What is a Letter of Credit (LOC)?
A Letter of Credit (LOC) is used in e-commerce to guarantee a buyer’s payment. It is issued by a bank or financial institution on behalf of a buyer and serves as a promise to the seller that they will pay for the purchased goods or services. If the buyer is unable to pay the amount, the bank is required to cover the amount.
Significance of Letter of Credit (LOC)
LOCs are significant in e-commerce because they provide a guarantee of payment to sellers, which can help to build trust and facilitate international trade. A LOC mitigates the risk of non-payment by providing a promise from a bank or financial institution that the buyer will pay for the goods or services being purchased.
Prerequisites for a Letter of Credit (LOC)
Consider the following aspects when using a letter of credit (LOC) in e-commerce:
- Determine your needs: You will need to assess your needs and determine whether a LOC is appropriate for your situation.
- Choose a bank: You must choose a bank or financial institution to issue the letter of credit on your behalf.
- Negotiate the terms: You will need to negotiate the terms of the LOC with the bank, including the amount of the credit, the expiration date, and any other conditions that apply.
- Review the agreement: You will need to carefully review the LOC agreement to ensure that it meets your needs and that you understand the terms and conditions of the credit.
- Communicate with the seller: You will need to communicate with the seller and provide them with a copy of the LOC so that they can verify that it is valid.
- Make payment: You will need to make payment by the terms of the LOC once the seller has delivered the goods or services as agreed upon.
Use Case of Letter of Credit (LOC)
Suppose a buyer uses a Letter of Credit (LOC) to purchase goods from an overseas seller. They work with a bank to set terms and provide a copy to the seller. After verifying that the goods meet the agreed-upon specs, the buyer pays the seller according to the LOC, and the bank releases the payment.