What is a Letter of Credit (LC) and how does it facilitate international payment?

• A. A bank's unconditional payment guarantee to the seller.
• B. A bank's conditional payment guarantee to the seller; payment is made upon submission of compliant documents.
• C. An agreement to prepay shipments.
• D. An insurance policy for shipments.

Answer: (B)

A Letter of Credit is a bank’s promise to pay the seller, but only if the seller presents specified documents that prove the terms of the sale have been met. That makes the payment conditional on documentary compliance rather than an automatic guarantee. The bank verifies documents such as the commercial invoice, bill of lading, and insurance certificate against the LC terms, and only then pays. After payment, the buyer’s bank is reimbursed by the buyer, so the bank’s obligation stands behind the documents rather than the goods themselves.

This arrangement reduces risk for both sides in international trade. The seller gains payment assurance even when the buyer is far away or unfamiliar, while the buyer maintains control and only pays once the required documents show the shipment is on its way. The LC provides a trusted, interbank mechanism that supports cross-border transactions by combining a bank-backed guarantee with documentary checks.

It’s not an unconditional payment guarantee, not an agreement to prepay shipments, and not an insurance policy for shipments.