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.
LC and DC indicative data is summarised below.
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%
- Advising bank
- Bank payment obligation
- Clean letter of credit
- Commercial risk
- Confirmed letter of credit
- Confirming bank
- Documentary collection
- Documentary credit
- Irrevocable letter of credit
- Issuing bank
- LOC backed
- Revocable letter of credit
- Standby letter of credit
- Term letter of credit
- Trade finance
- Uniform Customs and Practice for Documentary Credits