What is letter of credit?

A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.

Letters of credit are often used in international transactions to ensure that payment will be received. Due to the nature of international dealings including factors such as distance, differing laws in each country and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the supplier will not be paid until the bank receives a confirmation that the goods have been shipped. 

For exapmle, 

Seller “A” enters into contract with Buyer “B”. One of the terms of supply is that buyer will establish a letter of credit in favor of the seller through his bank. The buyer approaches his bank, which, on certain conditions, agrees to extend this facility. Under this facility, the buyer’s bank gives commitment of payment to the seller through his bank. The commitment is dependent upon the seller fulfilling specific conditions as per the L/C. The conditions are:

The seller should furnish proof of dispatch of goods or services and submit all the documents required under the L/C. Then, the buyer’s bank will pay the amount of bill drawn by the seller on the buyer under this agreement. International letter of credit are by and large, “irrevocable” (cannot be cancelled by the buyer without the consent from the seller).

A letter of credit is a documentary credit similar to that of a bank quarantee issued by a bank infavour of a buyer on behalf of a seller who is the customer of issuing bank concerned. Either Letter of Credit or Bank Guarantee has become an important aspect of modern international trade and commerce.

Letter Of Credit: 

    May be revocable or irrevocable - A document, consisting of specific instructions by a buyer of goods, that is issued by a bank to the seller who is authorized to draw a specified sum of money under certain conditions, i.e., the receipt by the bank of certain documents within a given time. An irrevocable L/C provides guarantee by the issuing bank in the event that all terms and conditions are met by the buyer (or drawee). A revocable L/C can be canceled or altered by the drawee after it has been issued by drawee's bank. A confirmed L/C is one issued by a foreign bank which is validated or guaranteed by a U.S. bank for a U.S. exporter in the case of default by the foreign buyer or bank.



Another definition...

 A document issued by a financial institution on behalf of a buyer stating the amount of credit the buyer has available, and that the institution will honor drafts up to that amount written by the buyer. It gives the buyer the prestige and financial backing of the issuing institution and satisfies the requirements of the seller in completing the transaction. The accepting institution has a prior agreement as to how the buyer will pay for the drafts as they are presented.



Another definition...



 

Letter Of Credit -- A commitment, usually by a bank on behalf of a client, to pay a beneficiary a stated amount of money under specified conditions.

 

value of L/C by dubious banks must be viewd carefully!

can any one tell what is wothout recourse clause means in an LC

“recourse” – meaning that the beneficiary can not consider the payment as final – until accepted by the issuing bank.
"Bill purchasing" most possibly on a without recourse basis.
"Bill discounting" is on a with recourse basis. Money is given in advance with the right to redebit should the bill not be paid in due course.
The negotiating bank has the right of recourse to the beneficiary of the documentary credit if cover is not received from the issuing bank, unless the negotiating bank has agreed to negotiate without recourse to the beneficiary, or has confirmed the credit.
However, in some Asian countries, negotiation is normally effected on a with recourse basis.
If the seller presents the documents to his bank, which is not the issuing bank and also not the confirming bank, then that bank negotiates the documents with recourse to him. This is because the seller's bank does not hold an undertaking to pay even though it is authorized to negotiate the documents.

The seller's bank on the other hand, may refuse to negotiate or give value of the documents to the seller. The principle of negotiation with recourse arises in a situation when:
• the negotiating bank is not able to obtain reimbursement from the issuing bank or from the applicant, that is the buyer because they have become insolvent
• Rejection of documents as a result of discrepancies in documents for which the negotiating bank is either holding an indemnity or has negotiated under reserve.
 

MR. Jvinod kumar can u pls explain this with the eg..is it something similar to rediscounting? as ur first defination .. " payment shud not be considered as final" then what  is the importance of L/C in that case...