letter of credit

Letter of credit (LOC)

A form of guarantee of payment issued by a bank on behalf of a borrower that assures the payment of interest and repayment of principal on bond issues.

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letter of credit

A promise of payment in the event that certain requirements are met. A letter of credit essentially substitutes the credit of a third party (usually a large bank) for that of a borrower. In the case of municipal bonds, an LOC generally permits a trustee to draw six months' interest and sufficient funds to retire outstanding bonds at par in the event of default.

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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.

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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.

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Letter of Credit

What Does Letter of Credit Mean?

A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. If the buyer is unable to make a payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.

Investopedia explains Letter of Credit

Letters of credit often are used in international transactions to ensure that payment will be received. Because of the nature of international dealings, including factors such as distance, differing laws in different countries, and the difficulty of knowing each party personally, the use of letters of credit has become a very important aspect of international trade. The bank also acts on behalf of the buyer (holder of a letter of credit) by ensuring that the supplier will not be paid until the bank receives a confirmation that the goods have been shipped.

Related Terms:
• Accounts Receivable—AR
• Cash and Cash Equivalents—CCE
• Money Market
• Accounts Payable—AP
• Debt