Letters of credit (L/C) are also known as documentary credits. All is means is that your bank or financial institution promises to pay a specified third party within a specified time against the presentation of documents which comply strictly with the terms of the letter of credit.

Letters of credit are used mainly for businesses that are involved in importing and exporting and they provide security for both parties. Letters of credit protect the exporter against non-payment because the bank effectively takes the risk and so long as the exporter presents the correct documentation they will be paid. Letters of credit also protect the importer against the exporter delivering something other than what was specified in the contract. For example if the importer is only prepared to close the deal if the seller supplies the materials by a certain date this can be written into the letter of credit. Both parties are therefore fully aware of what is required and the penalties of non compliance.

However it's important to note that letters of credit refer to the documentation representing the goods not the goods themselves. Banks won't examine goods on your behalf. It is also wise to check the creditworthiness of the bank involved - not all banks are equal especially in developing countries. All letters of credit contain common elements with no room for variation. They contain the payment undertaking given by a bank (issuing bank), on behalf of a buyer (applicant) to pay a seller (beneficiary) a given amount of money on presentation of specified documents representing the supply of goods within specified time limits. These documents must conform to terms and conditions set out in the letter of credit and be presented at a specified place.

There are several types of letters of credit, including:

• Irrevocable
• Unconfirmed
• Confirmed
• Stand-by
• Revolving
• Transferable
• Back-to-Back

Ideal for:
An importer who is buying goods that MUST meet exact specifications and wants to link payment with the meeting of those specifications without any room for discussion. Or an exporter who wants additional guarantees that payment will be made.

Security required:
Letters of credit are similar to supplying short-term finance and will be applicable to the same lending criteria. You may be required to provide security or personal guarantees for the funding.