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In the realm of international trade, letters of credit (LCs) play a pivotal role in facilitating secure
and reliable transactions between buyers and sellers. These financial
instruments serve as a guarantee that payment will be made to the seller upon
fulfillment of stipulated conditions, mitigating the risks associated with
cross-border commerce.
Demystifying Letters of Credit
A letter of credit is a formal document issued by a bank,
acting on behalf of its client (the buyer), to the seller. It guarantees that
the seller will receive payment for goods or services rendered, provided that
specific terms and conditions are met. These conditions typically involve the
presentation of shipping documents, invoices, and other supporting
documentation.
The Parties Involved in a Letter of Credit Transaction
A letter of credit transaction typically involves four key
parties:
Applicant: The
buyer or importer who initiates the letter
of credit process and instructs their bank to issue the LC.
Issuing Bank: The
buyer's bank that issues the letter of credit and assumes the primary
obligation to make payment to the seller.
Beneficiary: The
seller or exporter who receives the letter of credit and is entitled to payment
upon fulfilling the stipulated conditions.
Confirming Bank:
The seller's bank that may be involved in the transaction, providing an
additional layer of security by confirming the authenticity and validity of the
letter of credit.
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