FinTech Glossary

What Is a Letter of Credit

A letter of credit (LC) is a financial instrument issued by a bank that guarantees payment to a seller on behalf of a buyer, provided specified terms and conditions are fulfilled.

Business Context

A letter of credit is widely used in domestic and international trade to reduce payment risk between buyers and sellers.

It acts as a trusted intermediary mechanism where the bank assures payment, independent of the buyer’s financial position at the time of settlement.

LCs are especially common in cross-border transactions where parties may not have an established relationship.

How a Letter of Credit Works

The buyer requests an LC from their bank in favour of the seller.

The bank issues the LC, committing to pay the seller once the required documents are presented and verified.

Payment is made based on document compliance, not on the physical delivery of goods.

Types of Letters of Credit

Common types of letters of credit include:

• Irrevocable letter of credit
• Revocable letter of credit
• Confirmed letter of credit
• Standby letter of credit
• Sight and usance letters of credit

The type chosen depends on transaction risk and trade terms.