Irrevocable Letter of Credit (ILOC)
Definition:
An Irrevocable Letter of Credit (ILOC) is a financial instrument issued by a bank on behalf of a buyer (the applicant) that guarantees payment to a seller (the beneficiary) for goods or services, provided that the seller meets the specified conditions outlined in the letter of credit. The term "irrevocable" means that the letter of credit cannot be modified or cancelled without the agreement of all parties involved.
Example:
Acme Corporation, based in the United States, wants to import goods from a supplier in China. To mitigate the risk of non-payment and provide assurance to the supplier, Acme Corporation arranges for its bank to issue an ILOC in favor of the Chinese supplier. The ILOC specifies the documents the supplier must present, such as a commercial invoice and bill of lading, to receive payment. Once the supplier ships the goods and presents the required documents, the bank will release the payment, ensuring a secure transaction for both parties.
Why is it Important to Procurement?
ILOCs are important for procurement teams engaged in international trade, as they help to mitigate payment and supply chain risks. By using an ILOC, buyers can provide assurance of payment to suppliers, which can be especially important when dealing with new or unfamiliar suppliers. ILOCs also help to facilitate trade by enabling buyers to purchase goods from suppliers in countries where they may not have established credit relationships. For suppliers, ILOCs provide a secure means of payment, reducing the risk of non-payment and enabling them to offer more competitive terms to buyers.