A letter of credit refers to a document which is issued by financial institutions to offer a binding payment undertaking which is used mainly in trade finance. Letter of credit also acts as a method of payment for different transactions. It means that for getting the payment an exporter needs to redeem the letter of credit. In most of the cross border trade transactions between buyers and sellers letter of credit is used. For developing the land, letter of credit are used for ensuring that different services like sidewalks, roads, ponds etc. get completed.
A beneficiary who deserves the money, an advising bank with which the beneficiary has an account and the issuing bank with which the applicant has a bank account, are the parties which are involved in a letter of credit. Most of the letters of credit cannot be cancelled until an agreement is made between the beneficiary, the advising bank and the issuing bank. In order to get payment through a letter of credit, a person needs to present documents like bill of lading, commercial invoice and insurance papers testifying that the goods are insured against any damage or loss in transit.
There are different documents which are called for under a letter of credit. Financial documents which include bill of exchange, commercial documents like packing list and invoices, official documents which include license, inspection cert etc., transport documents, insurance documents and shipping documents like insurance certificate are those documents which are called for under a letter of credit. One should also know that any type of charges which are to be paid for getting the letter of credit issued, reimbursement etc. are to be paid by the applicant or according to the terms and conditions mentioned clearly in the letter of credit.
You should also make yourself aware about different risk situations related to the use of letters of credit. Several fraud risks are associated with letters of credit. For instance, forging of credit may take place. Risks which are taken by the applicant of a letter of credit include damage of goods in transit, short shipment, bad quality of goods, no delivery of goods etc. It is true that each party which is involved in a letter of credit bears some risk. However, a letter of credit is widely used for trade transactions between different parties in different countries.