What is Letters of Credit?
A letter of credit (LC) is a written undertaking by a bank, issued at the request of a buyer, to pay a beneficiary (the seller) a fixed sum upon presentation of stipulated documents within a specified period. It is widely used in international trade to mitigate payment risk for both parties.
How It Works
- The buyer applies for an LC at their bank, providing terms agreed with the seller.
- The issuing bank sends the LC to the seller’s bank (advising or confirming bank).
- On shipment, the seller presents shipping and trade documents complying with the LC terms.
- The bank examines documents and pays the seller, then debits the buyer (or extends financing under the LC line).
Saudi Context
Letters of credit are common in Saudi imports of capital goods, raw materials, and consumer products. Saudi banks supervised by SAMA offer conventional and sharia-compliant (Murabaha-based) LCs. The Saudi Customs office, now under ZATCA, releases imports against LC documents or independent delivery proof.
Example
A Saudi importer opens a SAR 2 million sight LC with a local bank to pay for German machinery. On shipment, the exporter presents compliant documents and the bank pays SAR 2 million, then debits the importer’s account or extends LC financing.