Finance Types

Letters of Credit

Letters of Credit

Letters of credit are issued by banks to guarantee to a seller that they will receive payment in full from a buyer by a specified time. They are often used in international transactions to protect both exporters and importers.

A letter of credit transfers risk from a seller to the issuer of the letter of credit. The seller gains certainty that the agreed amount will be received, even if the buyer ultimately fails to pay.

Exporters and importers of goods – businesses which trade internationally – are navigating differing laws, languages and the challenges which can come from distance and building relationships with other parties. Letters of credit have become an important means to ensure such transactions are secure, that payment is received, and the seller meets the agreed standards and quality of goods.

A buyer can apply for a letter of credit and will set out the goods they are buying and the terms and conditions under which they are purchasing (for example, quantity, quality, any certifications and the transportation to be used). The letter of credit is then issued by the buyer’s bank to the seller’s bank. It guarantees payment will be made to the seller, on time and in full, as long as all terms and conditions are met and the goods (or services) have been supplied as agreed. If the buyer is unable to pay any or the entire agreed amount, the bank will cover the shortfall.

For the buyer, the letter of credit ensures the supplier will not be paid until the goods have been shipped.

For more information, visit UK Export Finance (the UK’s export credit agency) and The Department for Business and Trade.