All you need to know about Letter of Credit!


A letter of credit adds a bank and financial institutions’ promise to pay the exporter to that of the foreign purchaser provided that the exporter has complied with all the conditions and terms of the letter of credit. The foreign client applies for issuance of a letter of credit from the buyer’s financial institution to the exporter’s bank and therefore is referred to as the applicant while the exporter is known as the beneficiary.

Types of Letter of Credit

There are 4 kinds of Letters of credit which are as under:

  • Revocable letter of credit.
  • Irrevocable letter of credit.
  • A standby letter of credit.
  • Revolving letter of credit.

Documentary letters of credit or documentary drafts are often used to protect the pursuits of each seller as well as the buyer. The bank that presents the Letter of credit needs to be a regular banker of the opener and must additionally be known to the beneficiary. Those methods require payment to be made based on the presentation of files conveying the title and the precise steps to be taken. The remote places of a Letter of credit should be suggested through an Indian financial institution, preferably it has to be confirmed.  Letters of credit and drafts may be paid at once or at a later date. Drafts that are paid upon presentation are known as ‘sight drafts’. Drafts that can be paid at a later date, often after the consumer receives the products, are called ‘time drafts’ or ‘date drafts’.

Basic Components of letter of Credit


The party using the letter of credit, generally the importer in a grain transaction.

The Issuing Bank

The bank that usually issues the letter of credit and assumes the duty to make a payment to the beneficiary, generally the exporter.


The party in whose choice the letter of credit is issued, normally the exporter in a grain transaction.


The amount of cash, commonly expressed as the most quantity, of the credit defined in a particular currency.

Terms and conditions

The requirements, which include files that must be met for the collection of the credit.

Obligation of Buyer and Seller

  • In the initial stage, the buyer concurs to buy goods from the seller. This agreement may be a buy order. In this example, the agreement is to use a letter of credit because of the mechanism of payment.
  • In this case, the buyer will approach the bank for a letter of credit, by signing the bank’s letter of credit utility/agreement form.
  • After the approval of the application, the issuing bank issues the real letter of credit and sends it to the beneficiary.
  • Having acquired, the bank will issue a warrant for the payment, then the seller ships the goods to the consumer(buyer).
  • After that, the seller will prepare the files referred to within the letter of credit and provide them to the issuing bank.
  • Later, the issuing bank will examine the given documents. If it determines that the documents follow the letter of credit, the issuing bank will pay the seller.
  • The bank that issues will obtain a fee from the applicant (customer) according to the terms of the application. The agreement and documents will be forwarded to the applicant.
  • The applicant makes use of the files to select the merchandise from the provider, finishing the letter of the credit cycle.

Rules Governing Letter of Credit

Uniform Customs and Practices (UCP) for documentary, credit is codified under the International Chamber of Commerce (ICC). It must be referred to that these regulatory measures are applied voluntarily with the aid of the banks and aren’t obligatory. This is because the UCP and practice for documentary credit are not certain by using law; however, it is universally accepted and has turn out to be a very crucial part of nearly all the documentation associated with the credits.

First Uniform Customs and Practice for Documentary credits were published in the year 1933 but after the first booklet, it has been revised several times. The Letter of credit issued under the UCP 600 is taken into consideration irrevocable, except the language simply establishes that the letter of credit is revocable.


With a letter of credit, a financial institution can neutralize a company patron and customer country threat by giving a confirmed documentary credit once the patron is based on the bank’s solvency, understanding, and professionalism. By engaging in export income transactions underneath an irrevocable letter of credit, the seller does not decide the credit status of the foreign purchaser. Letters of credit are issued in any one-of-a-kind bureaucracies from foreign banks and many financial institutions. The variations are because of disparities in customs and regulations of trade and finance within the country of origin of the issuing financial institution or monetary organization. If for any reason, a seller can’t comply with one or more conditions of a letter of credit, the seller needs to contact the client to arrange for one or more amendments to the original agreement.

This article is authored by Deva Dharshini K, Student at Dr. Ambedkar Govt Law College, Chennai.

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