What is a Letter of Credit and How Does it Work?

letter of credit

Importing and exporting is a complex process for quite a few reasons. One of them is the time involved in shipping overseas. Several months could possibly elapse between the time that a seller’s cargo leaves the seller’s port before it arrives in the buyer’s port for the buyer to pick up.

How is money for the cargo exchanged with this long time lag? The letter of credit.

What is a Letter of Credit?

In simple terms, the letter of credit is something a buyer will procure from a bank in their home country. This letter contains a list of terms and conditions set by the buyer.

Once those terms and conditions are met, the bank that the buyer has engaged (usually known as the issuing bank) will contact the sellers chosen bank (typically called the nominated bank); they will transfer the agreed upon funds to that bank.

Terms and Conditions

It is up to the buyer to provide a detailed list of terms and conditions. The following information should be contained in the terms and conditions:

  • What type of transportation is going to be used to move the cargo from one port to another?
  • What are the shipping ports that are going to be used during the import/export transaction?
  • Who must be notified when the shipment finally arrives at the destination port?
  • What is the latest date that the seller can ship out the cargo and have it be accepted by the buyer?
  • What sorts of documentation are going to be required in order to prove that the shipment is indeed what the seller and the buyer have agreed upon?
  • A very detailed description of the types of goods the buyer wished to purchase from the seller. Along with this list, a technical description might accompany this info.
  • The ultimate quantity (in an agreed upon unit) to be transferred to the buyer from the seller.
  • Who is the consignee for the shipment? Generally this is listed as the issuing bank, as they are the institution in charge of the cargo until the seller pays for it.

Process Upon Arrival

Once the seller’s goods have reached their destination port and been confirmed as arriving it is now up to the seller to prove to the nominated bank that he did indeed ship what was requested from the buyer.

All documentation on the shipment, such as bill of lading, shipping line documents and any other pertinent information will be brought to the nominated bank by the seller. He will use this information to prove he has done as agreed upon.

Once the shipment has been confirmed by the nominated bank, they will contact the issuing bank for payment. The issuing bank will then transfer payment for the shipment to the nominated band, and ultimately to the seller.

It is up to the buyer to reimburse the issuing bank for the amount that was sent to the buyer. Once this is done, the cargo is released to the buyer.

Cratex Group are experts in handling industrial packing as well as transloading of goods. Consider us for your next international import/export action.