What is the Import and Export Letter of Credit? (Importance and Key Features)

What is an Import Letter of Credit?

When a business conducts international trade, there are numerous different steps and procedures that they need to follow to safeguard themselves against possible litigation-related charges.

In this regard, it is also imperative for organizations to work alongside different banks and financial institutions to ensure that they act as intermediaries between both parties to ensure that the transaction smoothly takes place.

In this regard, an import letter of credit is one such document that acts as a safeguard and shield for businesses when procuring goods from another organization based in another country.

Import letter of credit enhances the creditworthiness of the business that is procuring the goods. Import letter of credit is mainly issued by the importer’s bank on behalf of the receiver of goods. The business that is selling the goods acts as a beneficiary.

Therefore, the main purpose behind the import letter of credit is to ensure the seller of the goods that he will eventually be paid for those goods and services.

This is primarily because the credit capacity of the buyer of goods is replaced by the credit capacity of the intermediary (the bank, in most cases) that is issuing the letter of credit.

Therefore, the main rationale behind the import letter of credit is to act as a guarantee towards the seller of the goods, and ensure that the seller is going to be paid for his goods in due time.

In the same manner, it reduces the chance of fraud, since it significantly amplifies the credibility of the transaction taking place.

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Features of Import Letter of Credit

Given that an import letter of credit is supposed to act as a guarantee of payment to the seller of the goods, it includes a number of details and specifics about information that is included in the draft of the import letter of credit.

Some of the most common and salient features of an import letter of credit are as follows:

  • It specifically states the parties involved – both the purchaser of the goods and the seller of the goods.
  • It also includes details about the beneficiary’s and importer’s banks. Both these intermediaries are important because they act on behalf of the actual client themselves.
  • Shipping documents and other trade agreements need to be presented to the customs officers for clearance of goods and services.
  • Any other terms and conditions involved in the import contract.

What is an Export Letter of Credit?

The main reason for an export letter of credit is to mitigate the credit risk involved in an international transaction.

In this regard, it is important to note the fact that an export letter of credit acts on behalf of the importer of the goods, by guaranteeing that the importer’s bank is going to pay the exporter the amount of the shipment, even before it is received by the buyer.

Given the fact that their import and export transactions are of significant nature, it is important to consider the fact that an export letter of credit is in place because it marginally improves the cash flow of the exporter of goods.

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Otherwise, if the importer were supposed to pay for the goods received directly, it would take a longer time for funds to be cleared, and hence, this would really impede the ability of the exporter to maintain their liquidity.

Therefore, an export letter of credit enables the exporter to receive the amount by getting into an agreement with the bank of the importer.

Import vs. Export Letter of Credit?

Import Letter of Credit and Export Letter of Credit have the same underlying purpose: to ensure that trade between two businesses located in different parts of the world is carried out smoothly.

However, both of them serve different purposes, both of which are mainly vested on the grounds of guaranteeing the exporter of goods that he will be paid for the goods purchased by the importer.

However, an import letter of credit acts as a communicative tool between the importer and the exporter that the importers bank is acting as an intermediary, and is guaranteeing payment, even if the importer defaults, or is unable to pay.

On the other hand, an export letter of credit acts as a communicative tool between the exporter and the bank, which helps the exporter receive payment for the goods and services before the goods have reached the importer.