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Letter of credit

A letter of credit is a document from a bank that guarantees payment. A letter of credit means a document provided. Example: for the exporter, by the importer, so that the exporter can draw his amount from the Bank. It usually states the period within which it can be drawn, the maximum amount, and refers to the documents accompanying it. A letter of Credit ranks as cash and must be honoured.


A letter of credit is documentary credit, which facilitates commercial relationship between an importer and an exporter, or in financing the shipment of merchandise from one country to another. The international laws govern the commercial Letters of Credit. The Law of Contract applies to every step in the Letter Of Credit from its commencement to the ending. After issuing the Letter Of Credit, The bank is liable to pay the payment. According to the terms of the contract, a Letter of Credit stipulates either for a sight draft or for a usance draft. A sight draft means payable on demand. A usance draft means payable at a later date prescribed by the parties.

Types of Letters of Credit

There are different kinds of Letters of Credit they are;

  1. Revocable of Letter of credit: In this system the issuing or advising Bank does not give any undertaking that drafts issued there under will be honoured. The issuing bank can cancel it any time by merely advising the beneficiary through the correspondent bank.
  2. Irrevocable Letter of Credit :In this system, once the issuing bank undertakes to issue the Letter Of Credit, it cannot revoke its decision, and the drafts issued there under will compulsorily be honoured.
  3. Confirmed Letter Of Credit : It constitutes a definite undertaking cannot be modified or cancelled without the agreement of all concerned.
  4. Unconfirmed Letter of Credit :The issuing bank advises the credit as either revocable or irrevocable but the correspondent bank does not add its confirmation thereto.
  5. Revolving Credit : It is a renewable credit. Under this system, the beneficiary can avail the amount up to Rs.1,00,00,000/- and one consignment to another consignment regularly , just with formal renewal with the bank.
  6. Transferable Credit : In this system, besides the buyer and seller, a merchant or agent enters into the agreement First the Letters of Credit is issued in favour of that merchant or agent incorporating the term “transferability”. When all the formalities are completed, the letters of Credit is transferred to the beneficiary.
  7. Negotiation Credit : In this system the bills are drawn on the importer himself. The bank’s services in the matter being requisitioned in order that exporter may be able to negotiate the bills he has drawn on the buyer. The credit is communicated by the bank to the beneficiary who can negotiate (sell) his draft to his local banker.

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