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How Letters of Credit Work?

How Letters of Credit Work

A Letter of Credit is a written undertaking issued by a bank, on behalf of its client, i.e. an importer or a buyer. This acts as a promise from a bank to make the payment to the seller, once they meet certain conditions. The working process behind the LC seems as same as the idea behind Escrow Payment System.  To provide a clear understanding of How Letters of Credit Work, we have come with an example below:

How Letters of Credit Work in International Trade?

First, a buyer and a seller agreed to conclude their trade deal together. They both agree on price, shipment and also, they decided when and how the goods will shipped to the buyer. To manage the risk related to trade, the seller requires the buyer to pay with an LC as soon as the shipment is done.

This is because; the seller wants assurance that the buyer will make the payment, once they receive the goods. And on the other hand, the buyer wants to get assured that the seller will supply the goods, as per the agreed contract. So, the buyer agreed to the seller’s demand and provides MT700 in favor of their supplier, after signing the contract or proforma invoice.

In this case, LC MT700 issued by a bank acts as a guarantee between the buyer and seller. And this confirms the seller that once they ship the goods to the buyer and meets all the LC terms, they will receive the payment from the bank.

The bank who acts as a guarantor releases the payment, only if the seller meets certain requirements. And this includes – submission of required documents, the shipment of goods / services as agreed on the contract or proforma invoice, and so on. Once the seller complies with all these LC terms, they will receive the payment of their supplied goods.

Key Features of Letters of Credit

Letters of Credit provides protection to both the parties involved in trading. The seller assured, because if they don’t receive the payment from the buyer, then the LC issuing bank is responsible for the payment. So, the seller has peace of mind that they will receive their payment in all means. Buyers also protected, because they didn’t want to pay for goods or services that they didn’t receive. This especially helpful for international trade transactions where the buyer and seller are in different countries; or, they have never worked before together; or the transaction might quite large enough to cause fiscal risks if something goes wrong.

How Letters of Credit Work?

  • Work as a credit certificate for buyers
  • Assures the seller that they will receive the payment at the time
  • Improves cash flow and expand oversea trade transactions
  • Help buyers to reduce or avoid pre-payment
  • Buyers can do any number of transactions at the same time

To avail a Commercial LC on behalf of your company, you need to contact your bank with a copy of the proforma invoice or Sales & Purchase Agreement. For this, your bank may require a certain percentage of cash margin or security to issue the LC. In case, if you’re unable to meet the demands of the bank, then your LC request will be declined.

So, to mobilize your import and export without blocking your cash funds, you can get help from Bronze Wing Trading L.L.C., the trusted LC Providers in Dubai. We can help you to avail LC without cash margin or third party assurance. Contact us today and avail the required LC within 48 banking hours.

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