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Letter of Credit

A statement issued by a bank to the buyer of a good stating that the seller will receive payment on time and in the correct amount. If the buyer fails to make payment, the bank will do so on his/her behalf. The buyer presents a letter of credit to the seller, which eliminates the risk that the seller will not be paid. Letters of credit have become very common in international commerce, as distance and other factors make it difficult for sellers to establish the creditworthiness of every buyer.

Line of Credit

An agreement between a bank and a company or an individual to provide a certain amount in loans on demand from the borrower. The borrower is under no obligation to actually take out a loan at any particular time, but may take part of the funds at any time over a period of several years. This agreement is fairly common in situations in which a business must make payroll but does not always have the operating income to do so, especially when its operating income is seasonal or otherwise varies from month to month. It is also called open-end credit or a revolving line of credit. See also: Credit Card.


letter of credit (LOC)

(Pronounce each letter of the abbreviation;it is not pronounced as a word.) An instrument issued by a bank or other financial institution (issuer) agreeing that it will pay money to another (beneficiary), on behalf of the bank's customer (account party), upon the happening of certain named events.There is usually an issuance fee of 1 to 2 percent of the face amount of the LOC.Modern banking regulations require the same underwriting as for a commercial loan.The LOC will set out the exact prerequisites to be met before the bank will issue payment. These usually include a particular time and place to present the original letter of credit and the exact documents that must accompany the letter.Some states still follow the old “strict compliance”rule holding that any deviation from the instructions, no matter how minor, will justify the bank in refusing to pay. Others follow a “substantial compliance” rule, so that minor typographical or syntax errors in the presenting documents will not justify nonpayment. See also the two types of letters of credit: documentary letter of credit and standby letter of credit.