This article is to provide in simple terms an explanation of how letter of credit works..

In the beginning there is a seller and buyer who want to conclude a business transaction.. Now they might or might not know each other or might or might not trust each other in terms of finiancial obligations..

Because of the time it takes for cargoes shipped from foreign ports to reach their destination, importers have to find a way of guaranteeing payment to exporters before the goods are received.. The answer is a letter of credit – an instruction by the importer’s bank to an overseas bank to pay the exporting company in advance.. The banks naturally charge interest for this service..