In domestic and international trade, trust and creditworthiness between buyers and suppliers are critical. A Letter of Credit (LC) is a financial instrument issued by a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount.
How an LC Works
- The buyer (applicant) requests their bank (issuing bank) to open an LC in favor of the seller (beneficiary).
- The issuing bank provides an irrevocable undertaking to pay the seller upon presentation of compliant shipping and commercial documents.
- The seller ships the goods and submits bills of lading, invoices, and inspection certificates to their advising bank.
- Once documents are verified against the LC terms, payment is released according to agreed terms (sight or usance).
Key Benefits for SMEs
- Purchasing Power: Enables businesses to procure high-value raw materials from premier domestic and global suppliers who require guaranteed payment terms.
- Cash Flow Preservation: Non-fund based facility that does not immediately deplete liquid cash reserves until the maturity/usance date.
- Risk Mitigation: Protects both parties against non-performance and non-payment risks.