What is letter of credit ? Why does an exporter need this document?

Letter of credit is a document which authorises a bank to pay the bearer a specified sum of money. Through it, the importer establishes a credit in favour of the exporter at the bank. It provides a useful means for settlement of a foreign trade transaction. Thus, a bank in the importing country issues a letter in favour of the shipper (exporter) containing an understating that bills of exchange drawn by him upon his importer up to the amount specified therein, will be honoured by it on presentation.

Kinds of Letter of Credit :

Letter of Credit is of following types :

(a) General or specific letter of credit : General letter of credit is in favour of all persons while special letter of credit is only in favour of the particular persons mentioned in it.

(b) Assignable or non-assignable letter of credit : If a letter of credit can be transferred by the importer to a third party, it is called an assignable letter of credit. A letter that cannot be so transferred by him is called a nonassignable letter of credit.

(c) Revolving letter of credit : Amount stated in this type of letter of credit remains fixed, whether, it is drawn by the exporter etc. if a revolving letter of credit is for Rs. 5 lakhs, the moment the export has withdrawn the total amount from the paying bank, the same letter will again become valid for a further sum of Rs. 5 lakh and so it goes on and on.