What is a characteristic of Letters of Credit?

A Letter of Credit is a financial instrument issued by a bank that guarantees payment to a seller on behalf of a buyer, provided that certain conditions are met. This mechanism is particularly beneficial when dealing with unfamiliar customers, as it mitigates risks associated with extending credit to new or unknown clients. It ensures that the seller receives payment as the bank backs the credit, which is especially important in international trade where trust and creditworthiness might not be established.

Using a Letter of Credit, the seller can have more confidence that they will be compensated for the goods or services provided, even if the buyer's creditworthiness is questionable. Therefore, this characteristic makes Letters of Credit ideal for situations where the seller might not have an established relationship with the buyer.

While Letters of Credit offer significant security, they often come with costs that can make them expensive, which counters the idea that they are always inexpensive. Additionally, established relationships may often rely on other payment methods due to the mutual trust built over time. Cash on delivery transactions are typically a separate method of payment that does not require a Letter of Credit. Thus, the unique security and trust aspect of Letters of Credit make them particularly advantageous for transactions involving unfamiliar customers.