Question

What is a letter of credit? Why does an exporter need this document?

Answer 1

A letter of credit is issued by the bank of an importer guaranteeing to honour a draft of a certain amount drawn on it by the exporter. It is an important document because, in international transactions, there is always a risk of the importer defaulting on payment once the goods are received. Thus, to minimise the risk of such defaults, the exporter often demands a letter of credit. A letter of credit enables the exporter to assess the creditworthiness of the importer. It is the most appropriate and secure method of payment for settling an international transaction.