In business transactions, the seller of goods or services requires some guarantee of payment. After evaluating the buyer’s creditworthiness, the buyer’s bank issues a letter of credit (LC), which the buyer sends to the seller.
The buyer deposits funds totaling the amount of the letter of credit into his own bank account. The buyer cannot withdraw these funds while the letter of credit is in effect. With the buyer’s funds as security, his bank agrees to issue a letter of credit.
Upon the seller delivering goods or services, she turns to the buyer’s bank for payment. After the buyer’s bank is satisfied that the seller has met her obligations, funds are released to the seller’s bank account or a check is made out in the seller’s name.
In an unconfirmed LC, the seller interacts solely with the buyer's bank for payment approval. The seller's bank pays her only after receiving funds from the buyer's bank.
If irrevocable, the buyer cannot cancel or modify the letter of credit once it is issued. Most LCs are irrevocable, as few sellers would let buyers change or cancel their payment obligations.
Unconfirmed Irrevocable LC
Typically, letters of credit for domestic and international business are unconfirmed and irrevocable, giving the seller reasonable assurance of payment.