What is Letter of credit?
Letter of credit is the most important document in international trade. It forms the basis of most of the transactions in world trade. A letter of credit is a document of authority for guaranteeing payment by the importer to the exporter through his banking channel. Importer’s bank undertakes guarantee for payment on behalf of the importer. That is, if the importer fails to pay, it is the bank that has issued the LC that becomes liable to pay to the exporter.
Parties to the letter of credit
There are different parties to a letter of credit. They include the opener, issuer, beneficiary, confirming bank, notifying bank, paying bank and the negotiating bank.
1. The opener: The opener is the buyer (importer). A letter of credit is opened on the request of the buyer.
2. The issuer: The issuer is also known as the opening or issuing bank. The issuer is actually the bank in the importer’s country, issuing the letter of credit at the initiative of the importer.
3. The beneficiary: The seller or exporter is the beneficiary in whose favor the letter of credit is issued.
4. The confirming bank: The confirming bank will be situated in the exporter’s country. It guarantees credit on the request of the issuing bank. The confirming bank is the primary party to the credit and it undertakes all the obligations of the issuing bank. Even if the issuing bank fails, the confirming bank is bound to honor its commitment.
5. The notifying bank: The notifying bank notifies the beneficiary that the credit is opened in his favor. If the letter of credit is confirmed, the con6rming bank advises the beneficiary accordingly.
6. The paying bank: A draft or bill of exchange is drawn on the paying bank. The paying bank may be the issuing bank, the confirming bank or the notifying bank.
7. The negotiating bank: The negotiating bank pays or accepts the draft of the exporter. When no paying bank is specified in the letter of credit, the beneficiary may go to any bank of his choice and present the draft and related documents under the credit. If the bank agrees to negotiate the documents, it becomes an endorsee and bonafide holder of the draft. It has recourse on the drawer of the bill until it is accepted and paid by the drawer.