Letter of credit briefly explained (or at least what I make of it)

As our first block is coming to an end and we are getting ready to plunge ourselves into the uncertain and complex world of international trade law, I took a sneak peek into our syllabus. Between many commercial concepts prescribed, I noticed the letter of credit, a very interesting mechanism employed in international commercial transactions especially in the carriage of goods by sea.

A typical letter of credit

A letter of credit is essentially a warranty of payment. Both a sign of financial competence for the international buyer and a safe heaven for the seller, in case that the buyer defaults. To get more specific a letter of credit is actually...a letter; issued by the buyers bank and guaranteeing payment (by a transaction from the buyers to the sellers bank) of an agreed sum , in case the buyer is unable to pay the commercial transaction himself. To get the letter, the buyer usually needs to either deposit the agreed sum of money in the bank that is issuing the letter or to take a loan from the bank. One of the most important aspects of the letter is that it has a termination date, meaning that if the buyer fails to pay up in the prescribed time (a certain date) the seller can ignore the buyer and go directly to his bank to collect what he is owed.

In an international market where a transaction can be affected by a large number of unforeseen factors (e.g. pirates, natural disasters, fall of regimes, and stock market crashes) a letter of credit provides much needed safety, essentially creating a protective barrier and guaranteeing that no matter  what happens, the agreed transaction will go through. Further more the letter of credit also deters fraud, a matter difficult to deal with in an international environment with many jurisdictions and little judicial control (especially if the fraudster is in the other side of the world).  

Further facts about the letter of credit

1.Understanding and Using Letters of Credit 

2.A sample of a letter of credit

ps. still writing child labour essay...I now can confidently say that international labour law should be called international bureaucracy law...so much red tape so many committees...so little action...