What is Letter of Credit? How it’s Going to help in Project Financing?

Letters of credit are assurances or guarantees to sellers that they will be paid for a large transaction. They are particularly common in international or foreign exchanges. Think of them as a form of payment insurance from a financial institution or another accredited party to the transaction. The most common types of letters of credit are commercial letters of credit, standby letters of credit, revocable letters of credit, irrevocable letters of credit, revolving letters of credit, and red clause letters of credit, although there are several others.

LC is an arrangement whereby the issuing bank can act on the request and instruction of the applicant (importer) or on their own behalf. Under an LC arrangement, the issuing bank can make a payment to (or to the order of) the beneficiary (that is, the exporter). Alternatively, the issuing bank can accept the bills of exchange or drafts that are drawn by the exporter. The issuing bank can also authorize advising or nominated banks to pay or accept bills of exchange.

A letter of credit is a transactional deal, under which the terms can be modified/changed at the party’s assent. In order to be negotiable, a letter of credit should include an unconditional promise of payment upon demand or at a particular point in time.

A letter of credit can be revocable or irrevocable. Since a revocable letter of credit cannot be confirmed, the duty to pay can be revoked at any point in time. In an irrevocable letter of credit, all the parties hold power, it cannot be changed/modified without the agreed consent of all the people.

A letter of credit can be transferred, also the beneficiary has the right to transfer/assign the LC. The LC will remain effective no matter how many times the beneficiary assigns/transfers the LC.

There isn't a set fee for letters of credit. The bank you use will decide on costs. You can expect to be charged some percentage of the amount covered by the letter of credit. This amount is typically no more than a few percentage points, but it'll depend on variables like your credit history.