A letter of credit is essentially a financial contract between a bank, a bank's customer and a beneficiary. Generally issued by an importer’s bank, the letter of credit guarantees an exporter will be paid once the conditions of the letter of credit have been met.
What is it used for?
Letters of credit are used to minimize risk in international trade transactions where the buyer and the seller may not know one another.
As an importer, using a letter of credit can ensure that your company only pays for goods after the supplier has provided evidence that they have been shipped. It also allows you to conserve your cash flow, since you don’t have to make any advance payments or deposits to the exporter. Finally, the letter of credit gives you instant credibility with an exporter by demonstrating your creditworthiness.