A letter of credit is a revocable commitment by a bank issued on behalf of its client and promising to pay a specific sum of money to a beneficiary upon compliance with the instructions of the letter of credit. True False
The correct answer and explanation is:
The correct answer is False.
A letter of credit (LC) is a financial document issued by a bank that guarantees payment to a beneficiary on behalf of its client, provided certain terms and conditions are met. However, the statement that a letter of credit is a “revocable commitment” is incorrect. A standard letter of credit is typically irrevocable, meaning it cannot be altered or canceled without the agreement of all parties involved: the issuing bank, the beneficiary, and the applicant (the party requesting the letter of credit).
An irrevocable letter of credit offers security to the beneficiary that the bank will make payment, as long as the beneficiary adheres to the conditions specified in the document. This makes the arrangement more reliable, especially in international trade where there might be concerns about the solvency or trustworthiness of the applicant.
If the letter of credit were revocable, the bank or the applicant could change the terms or cancel the LC at any time without the beneficiary’s consent, which would undermine its purpose. The irrevocability ensures that the beneficiary can trust that the payment will be made once the conditions are met.
Letters of credit come in different types, such as sight, time, or revolving letters of credit, and they can also be issued as confirmed or unconfirmed. The terms and conditions of the letter of credit specify the documents required for payment, such as shipping documents, invoices, or inspection certificates, which must be presented by the beneficiary in accordance with the LC’s instructions. This helps to facilitate secure and efficient trade transactions.