A documentary letter of credit is a written obligation of the issuing bank to pay a certain amount according to conditions defined in the letter of credit. Unlike the bank guarantee, the letter of credit provides not only a security but it is also a payment instrument. It is issued upon request of the client (applicant, buyer) in favor of the beneficiary/seller. Payment is made upon presentation of required documents in full compliance with terms and conditions of the letter of credit. Because of the many embedded functions, such instruments provide significant advantages for both the seller and buyer.
Benefits for the beneficiary under the letter of credit (the seller)
- The seller has an outstanding receivable toward the bank and not toward the buyer
- The receivable under the letter of credit can be negotiated or purchased to obtain funds in advance
- The seller can obtain financing from its bank, subject to purchase of the goods secured by the letter of credit
- The seller can mitigate the payment, commercial and country risks
Benefits for the applicant under the letter of credit (the buyer)
- The buyer can be certain that the payment will be made only if the stipulated in the letter of credit conditions are met
- The buyer may negotiate more favorable payment terms in case the payment is secured by letter of credit
- The buyer is able to demonstrate trust and reliability
- A documentary letter of credit is governed by the Uniform Customs and Practice for Documentary Credits of the International Chamber of Commerce, UCP600 (ICC Publication 600)