Letter of credit is the term which is used in international trade or transactions. It can be defined as a facility or arrangement between the the bank or financial institution and importer where the bank agrees to pay to the exporter when the exporter present the documents as required by the letter of credit. Given below are some of the advantages of letter of credit –
- Since it is the bank which pay to the exporter, the importer does not has to worry about the payment and he or she can pay the amount in installment to the bank and hence it results in less burden for the importer as that money can used for business. However one has to pay interest to the bank for availing letter of credit facility from the bank.
- Exporter also get the advantage because he or she is assured that payment will be made of goods sold by the exporter which would not have been possible if the bank was not involved because demanding payment directly from importer would have been a cumbersome and tough task.
- It also nullifies the foreign exchange risk associated with international sales and hence that is the reason why majority of importer and exporter take letter of credit facility from banks.
- Letter of credit clearly lays down all terms and conditions and hence both the parties that is importer is assured about the quality of goods purchased and exporter is assured about payment of money by importer on time.
- There are many variants of letter of credit like Revocable Letter of Credit, Revolving Letter of Credit, Deferred Letter of Credit, Back to Back Letter of Credit and so on which in turn provides lot of flexibility to the people taking these facilities from banks and the parties can use different variant for different transactions or while dealing with different parties.
Hence from the above one can see that letter of credit is of paramount importance for international trade and it would not be wrong to say that letter of credit is one of the pillars of international trade and without it, it would be very difficult if not impossible for international trade to flourish.