Terms: Letters of Credit

A letter of credit is a guarantee from a bank that a specific obligation will be honored by the bank if the borrower fails to pay. Letters of credit can be useful when dealing with new vendors who may not be assured of a company's credit worthiness. The bank would then offer a letter of credit as an assurance to the vendor of payment. Although no funds are paid by the bank, the credit requirements for a line of credit and a letter of credit are similar.