Definition of Letter of Credit in Banking

Letter of Credit in Banking




In different countries goods are import and exports by their businessman, for import and export the reliable source for payment for importer is Letter of Credit. L.C is issued by the buyer bank in the favor of seller bank,


Definitions by Frank Henious


“A letter of credit is a written instrument, issued by the buyer’s bank, authorizing the seller to draw in accordance with certain terms and conditions”



By Pritchard


A letter of credit is a commitment on the part of the buyer’s to pay or accept draft, drawn upon it, provided such drafts, do not exceed specified amount.



Parties in letter of credit Buyer/ Importer/opener


The person who wants to pu chase goods and commodities from foreign as well as at whose request letter of credit is opened is call d importer.



Importer bank/ Buyer bank


The bank, which opens the letter of credit at the buyer request is called buyer bank






The person who wants to sell the goods to foreign country as well as to whose favor letter of credit is open


Exporter bank/ seller bank



The bank which makes the payment to the exporter after receiving the letter of credit is called seller bank.



Requirements of opening letter of credit Sales contract


First of all there must be a contract between buyer/importer and seller/exporter of sales and purchase, and they agreed all term and conditions as well as mode of payment Import License. The banker demands the applicant about import License, and indent of goods to be imported. After checking such document allow importer to file on application on printed form.



Application form


Its means the agreement for irrevocable letter of credit, i.e. filled up by the banker and signed by the Importer. As well as it contain all term and conditions of the sale agreement.


Completion and scrutiny of the form


Letter of credit is filled by the banker as per information provided by the applicant (buyer) the banker complete and scrutinizes the documents.



Opening letter of credit


When all the information is completed then banker opened letter of credit on the behalf of importer.



Information to exporter bank


The issuing bank informs the seller bank about the issuance the letter of credit. And after it 3 copies are made by the issuer bank. One copy retain by the buyer bank, other 2 se d to seller bank, out of which one copy send to seller by the seller bank.


Information to the seller


The seller bank inf rm to seller about receiving letter of credit form buyer bank, then seller send the good to buyer according to term and condition and shipping documents to seller bank. After checking documents the seller bank sends it to buyer bank.



Margin on letter of credit


Central bank of Pakistan decides the percentage of amount to be paid to the issuing bank, by the importer. Such chargeable amount is called margin.



Payment to the Exporter


The buyer bank, on receipt of shipping documents, make payment to seller bank, and seller bank make payment to seller.



Types of letter of credit


Irrevocable letter of credit


A letter of credit which cannot be cancelled is called irrevocable L.C. such type of L.C provided fully protection to exporter.


Revocable letter of credit


A letter of credit which can be cancelled by the importer bank at any time without any obligations. After this such L.C is not acceptable by the exporter.



Confirmed letter of credit


In which the exporter bank gives guarantee to make payment to the exporter even if the importers bank fails to make the payment. And on the other hand importer bank also give the guarantee to importer. So the seller gets double protection of payment.


Unconfirmed letter of credit


A letter of credit in which the exporter bank does n t gives and guarantee to exporter about payment. The bank give payment if the importer the provided the payment to exporter bank



Documentary letter of credit


In which the payment is made after receiving following documents



Packing list

Insurance policy Bill of lading



Clean letter of credit


A letter of credit in which there is no condition of document attached for the payment.


Fixed letter of credit


It is a letter of credit in which the credit is available for a fixed total amount payable in one or more than one draft.


Revolving letter of credit


In which the amount of credit can be revolved or renewed on the fulfillment of credit conditions. And all the term and conditions can be renewed by the commitment of both parties.


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