What is the Letter of Credit?
Letter of Credit is mainly a contract, from the bank guaranteeing that the other party involved in a certain transaction will pay the full amount under certain conditions and terms. The bank acts as a mediator between the two parties involved and will also hold back the payment until those conditions in the contract are met. Due to the complications that arise with international dealings, it has become a very essential aspect of business transactions and international trade.
How Does the Letter of Credit Work?
This Letter of Credit helps greatly in moderating any issues or risks that might arise from either party not delivering what is expected of them. There are two key reasons used in letters of credit.
- This letter establishes the obligations of both parties involved and also states the amount of payment to be afforded by the buyer.
- The bank will overlook the transactions and legwork to be done to ensure that the buyer can afford the full amount.
- A third party, in this case, the bank holds onto the payment needed to complete transactions.