A financial instrument issued by a bank (the issuing bank) at the request of its customer (the applicant) in which the issuing bank undertakes to pay a third party (the beneficiary of the letter of credit) a fixed amount at a specific time or on the occurrence of specific events (such as, the delivery of certain documents).

Letters of credit are commonly used as a payment mechanism or guarantee of an applicant's payment obligations under a commercial contract. A letter of credit allows the beneficiary to substitute the issuing bank's stronger credit position for that of the applicant's and eliminate the risk to the beneficiary that the applicant will not pay.

There are primarily two types of letters of credit:

For more information on letters of credit generally, see Practice note, Letters of credit: overview.