Letter of Credit (Akkreditiv)
A letter of credit is a bank's conditional payment undertaking in favor of a seller, honored against presentation of contractually specified documents.
Concept
A letter of credit (documentary credit) is a conditional and abstract payment undertaking issued by a bank on behalf of a buyer in favor of a seller, which the bank is obliged to honor against presentation of the documents specified in the credit — such as freight documents, certificates of origin, or insurance policies.
Relevance in Foreign Trade
The letter of credit is a central payment and security instrument in international trade, as it significantly reduces the seller’s risk of non-payment and the buyer’s risk of receiving non-conforming goods, by involving a neutral bank as paying agent.
Interaction with Credit Insurance
Letters of credit are often used alongside export credit insurance: while the letter of credit secures payment upon compliant presentation of documents, credit insurance covers further risks, such as the issuing bank’s failure to honor the credit as a result of political events.