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Letter of Credit / Standby Letter of Credit

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Definition:

A letter of credit is a document issued by a bank which provides a guarantee of funding for a business. Letters of credit are used particularly in overseas transactions, where a company in one country wishes to purchase goods or services from a company in another company. The bank reviews the buyer's credit and provides a guarantee of payment in case of default by the buyer. The person receiving the letter of credit is considered the "beneficiary."

While a letter of credit is issued for a guarantee in a specific transaction, a standby letter of credit is a general letter providing a guarantee for a specific period of time.

Most letters of credit are irrevocable, but occasionally a letter of credit is revocable; that is, it can be canceled by the bank without notifying the beneficiary.

If a business wishes a letter of credit, sometimes it must take out a loan for collateral. The SBA Export Express loan program provides funding for letters of credit for small businesses in the U.S. that wish to purchase from foreign suppliers.

Also Known As: A letter of credit can be compared to a certified check for an individual, which promises that the check will be honored by the bank.

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