Letter of credit

(LC or sometimes LOC).

A promise document issued by a bank or another issuer to a third party to make a payment on behalf of a customer in accordance with specified conditions.

Letters of credit are frequently used in international trade to make funds available in a foreign location.

Letter of credit contrasted with documentary collection

Letters of credit are often contrasted, from the perspective of a seller, with an alternative structure of documentary collections.

A letter of credit is a direct obligation of a bank to pay (against specified documents).

A documentary collection means a bank collecting payment from the buyer (by presenting documents to the buyer).

A letter of credit therefore gives superior protection to the seller against credit risk or delayed cash flow, or both.

For this reason letters of credit are more expensive to arrange.

Compared with documentary collections (DCs), letters of credit (LCs) are used for larger transactions, and a larger total value of transactions.

Average transaction sizes (US exports)

LCs: US$ 0.5 - 1 million

DCs: US$ 0.1 - 0.2 million

Proportion of world trade in goods

LCs: 10 - 15%

DCs: 1 - 2%

See also

• Advising bank
• Bank payment obligation
• Clean letter of credit
• Commercial risk
• Condition
• Confirmed letter of credit
• Confirming bank
• Credit
• Documentary collection
• Documentary credit
• Irrevocable letter of credit
• Issuing bank
• LOC backed
• Standby letter of credit
• Trade finance
• Uniform Customs and Practice for Documentary Credits

Other links

Trade finance around the world, Centre for Economic and Policy Research, 2016

Letters of credit and supply chain finance, Will Spinney, ACT 2009