December 30, 2022
Shreeja Ray

Letters Of Credit or Letter of Undertaking

The buyer's payment to the sellers is ensured by a letter of credit (LC). It guarantees timely and complete payment to the seller and is issued by a bank. In the event that the purchaser is unable to make such a payment, the bank makes the whole or remaining payment on the purchaser's behalf.

In exchange for the commitment of securities or money, a letter of credit is granted. A fee, or a proportion of the size or value of the letter of credit, is often collected by banks.

Letters of Credit: Their Value

Letters of credit are a dependable payment method since international trading involves complicated issues like distance, disparate legal systems, and absence of personal interaction. Letters of credit are governed by the "International Chamber of Commerce Uniform Customs and Practice for Documentary Credits."

Who signs a letter of credit?

1. The importer, who is the applicant, asks the bank to issue the LC.

2. The bank that issues the LC (sometimes referred to as the opening banker of the LC) is the issuing bank.

3. Beneficiary (exporter) (exporter).

How many distinct varieties of letters of credit are there to choose from?

The following is a list of the five most common kinds of letters of credit that are available:

1. Credit Letter for Commercial Transactions

This type of letter of credit involves direct payments, where the bank pays the seller at the time of the purchase, regardless of whether the buyer can pay or not.

2. Contingent Obligation Letter of Credit

Similar to a commercial letter of credit, this type of letter of credit involves payment on the condition that it is made only in cases where the buyer is unable to make their own payments. This doesn't involve a direct payment from the bank at the time of the purchase.

3. Letter of Credit With Revolving Limits

This type of letter of credit involves payment, but there are limits on how much can be taken out. For example, the bank might let the customer take out as many draws as they want during a certain time period, but only up to a certain limit.

4. Letter of Credit Issued to Travelers

As the name suggests, this type of letter of credit is most useful for people who are going abroad.

It is a promise that international bank drafts will be paid by the bank that made them.

5. Letter of Credit with Confirmation

In this type of letter of credit, there are two banks: one issues the credit letter on behalf of the buyer, and the other is the seller's confirming bank, which acts as insurance in case either the buyer or the issuing bank can't pay.

Does a letter of credit have a cost?

The cost to issue a letter of credit is paid by the bank. The cost of a letter of credit relies on a number of variables, including the risk level and letter of credit type.

What benefits does a letter of credit provide to buyers?

A letter of credit typically supports a beneficiary or a seller in an exchange arrangement, ensuring that the seller receives the funds from either the buyer or the issuing bank.

What outcomes are possible in the event that the buyer is unable to honor the terms of the Letter of Credit and pay the seller?

In the event that the buyer is unable to make payment to the seller, the letter of credit stipulates that the bank will assume responsibility for the transaction and make full payment to the seller on behalf of the buyer.


What are the steps involved in requesting a letter of credit?

You can ask your bank for a letter of credit by filling out the appropriate paperwork. Gathering all of the deal's information, such as the goods or services being traded, the payment amount, the estimated delivery date, and other facts along similar lines, can be one of the most challenging aspects of the application process. After you have provided your bank with an explanation of the circumstances, your bank will choose whether or not it will provide a letter of credit.

How much does it cost to get a letter of credit?

There is no predetermined cost associated with letters of credit. The fees that you incur will be determined by the bank that you use. You should prepare yourself to pay a certain proportion of the total amount that is covered by the letter of credit. This sum is normally no more than a few percentage points, but it will depend on factors like your credit history. Typically, this cost is not more than a few percentage points.

What does it mean when a utility company issues a letter of credit?

These letters of credit are distinct from the ones outlined in the previous paragraph. Instead of paying a cash deposit, new customers of certain utility companies are given the option of submitting a letter of credit from their prior utility provider in its place. If you have never been late with a payment, your previous utility company will let your new one know that you are a dependable client because of this fact. You may also hear people refer to these as "credit reference letters."

Related Blog Post