A letter of credit can be defined as an understanding under which a bank acting at the request of a customer undertakes to pay to a third party a fixed amount by a given date which is agreed on by both the customer and the third party. Letters of credit are used mostly in international trade transactions of major value, for deals between a supplier in one country and a customer in another.
There are 4 parties to a letter of credit. They are –
1. Applicant – It is the importer who has bought the goods and wants to pay for those goods by opening letter of the credit through bank.
2. Issuing Bank – It is the bank which opens the letter of credit on the request of the importer.
3. Beneficiary – It is the exporter who has sold the goods and in whose favor letter of credit is opened.
4. Advising Bank – It is the bank which informs the exporter about the letter of credit being opened at the request of issuing bank.