A letter of credit (LC) is a written document in which a bank (issuing bank) pays a third party (beneficiary) or its designated party with specified documents in accordance with the requirements and instructions of the applicant or on its own initiative under the conditions of meeting the terms of the letter of credit. That is, a letter of credit is a written document issued by a bank that promises to pay conditionally. In international trade activities, buyers and sellers may not trust each other. The buyer is worried that the seller will not ship the goods as required by the contract after the advance payment; the seller is also worried that the buyer will not pay after the goods are shipped or the shipping documents are submitted. Therefore, two banks are needed as guarantors for the buyer and seller to collect payment and deliver documents on their behalf, replacing commercial credit with bank credit. The tool used by the bank in this activity is the letter of credit.
It can be seen that a letter of credit is a certificate that the bank guarantees payment conditionally, and it has become a common settlement method in international trade activities. According to the general provisions of this settlement method, the buyer first deposits the payment to the bank, and the bank opens a letter of credit and notifies the bank where the seller opens an account in another place to pass it on to the seller. The seller ships the goods according to the terms stipulated in the contract and the letter of credit, and finally the bank pays on behalf of the buyer.