What is a Letter of Credit?



A Letter of Credit (LC) is a bank document that acts as a contractual commitment by a foreign buyer’s bank to the exporter that the buyer will transfer the agreed payment amount once the goods are shipped.
When it comes to smooth facilitation of international trade, the Letter of Credit acts as an important payment instrument, as it helps in mitigating the different risks associated with the trading of goods, for both buyers as well as sellers. A Letter of Credit helps provide the required documentation as proof to the exporter’s bank for timely transfer of payment.
On sending a Letter of Credit, the banks charge a fee, besides a collateral, from the buyer as the LC also acts as a guarantee from the buyer’s bank so that in case the buyer is unable to make the payment amount, the bank shall cover the full or remaining amount on behalf of the importer/buyer.

This helps businesses explore new customers in global markets as the exporters get a guarantee of payment, while importers benefit from reasonable payment terms. Though the primary purpose of a Letter of Credit is to act as a payment instrument, it also has certain secondary purposes due to which there are different types of Letters of Credit.
Types of Letters of Credit:
1 Sight Letter of Credit: This type of Letter of Credit can be deemed as payment at sight or Letter of Credit at sight. This document assures the seller of timely payment against any services or goods that are being exported. The amount is paid when the exporting party presents the Sight Letter of Credit and other requisite documents to the buyer’s bank. The company that offers a Letter of Credit makes payments to the other party when all the conditions of the Letter of Credit are fulfilled.
The three parties involved in this type of transaction are the buyer, seller and the issuing bank. When it comes to international trade, a Sight Letter of Credit decreases the risks involved with the business and provides protections to the involved parties.
2 Usance Letter of Credit: Also known as the Deferred or Term Letter of Credit, this type of LC allows the buyer and the seller to decide a credit period to the importer, i.e., a tenure for making the payment in advance.
Based on their tenure, the Usance Letter of Credit is classified into different types – it allows the buyer to make a payment within days or days or or even days of issuance of the Bill of Lading.
In case of the Usance Letter of Credit, there is an option of deferred payment for the buyer, which is in complete contrast to the Sight Letter of Credit where the buyer is required to make the payment immediately on receiving the documents.
3 Standby Letter of Credit: This type of Letter of Credit is typically used to ensure that the applicant will meet the payment or contractual obligations agreed upon by both the exporter and importer. It adds a layer of protection to ensure the timely transfer of payment to the exporter for a completed shipment of goods.
Under this LC agreement, the buyer’s bank agrees to make the payment to the seller in case the buyer is unable to transfer the agreed upon payment amount. This payment instrument is meant to guarantee that all financial obligations are met if any unforeseen event prevents the fulfillment of a deal.
Collaborating with a bank to explore overseas markets
Exporting goods overseas requires dealing with buyers or customers that businesses usually do not know. In such a scenario, the suppliers may require some kind of payment assurance for doing a business transaction.
To facilitate the whole transaction process for businesses involved in cross border trade, ICICI Bank offers the
Letter of Credit service that provides payment assurance to the suppliers, which in turn, facilitates easier import and export of goods.
Further, it also helps build and strengthen business relationships with clients through an assurance of timely payments. In addition, small businesses get the chance to explore new business opportunities without having to bear the risk of default.
How to avail the Letter of Credit service from ICICI Bank?
It is a simple seven-step process, which starts with the buyer and supplier signing a contract stating that the payment will be made based on a Letter of Credit.
As the next step, the buyer needs to approach
ICICI Bank for the issuance of a Letter of Credit in the supplier’s favour. The bank then issues the same, advised by its own branch or correspondent bank in the supplier’s country.
Thereafter, the advising bank advises a Letter of Credit to the supplier. Once the supplier receives the Letter of Credit, the shipment of goods is sent forth and the LC documents delivered to the supplier’s bank. The supplier’s bank will then send the documents to ICICI Bank for a transfer of payment, post which, the buyer pays the agreed amount to ICICI Bank and gets the documents in turn.
Conclusion
A Letter of Credit essentially serves two key purposes – protecting the cash flow and providing much-needed security for businesses engaged in cross-border trade, in the event something unexpected occurs. With the backing of a bank, a Letter of Credit provided by a potential customer or partner can assure businesses that their financial obligations will be fulfilled. With ICICI Bank’s Letter of Credit services, that facilitates easy online transactions, businesses can expect to scale and venture into foreign markets with ease.