Documentary Letter of Credit

• Written commitment of the bank to pay a specific amount when the letter of credit terms and conditions defined by the buyer are met
• Commitment to the seller is irrevocable and the bank accepts it at the buyer’s request
• One of the most important and sophisticated payment instruments used in domestic and international trade
• Buyer does not make a payment before the seller meets the terms defined by the buyer
• Seller is guaranteed that the bank opening the letter of credit will pay him for the goods if the letter of credit terms and conditions are met

Different types of letters of credit:

• Import, export (supplier, customer)
• Notified, confirmed
• Transferable, revolving, standby letter of credit

Transaction scheme

1) Purchase contract is signed between the seller and the buyer

2) Based on the purchase contract and its terms, the buyer asks its bank to open a letter of credit

3a) The seller ships the goods

3b) The seller gathers documents stipulated by the L/C and sends them via its bank to the buyer’s bank, which checks them and, if they meet the terms and conditions, passes them to the buyer

4) The buyer’s bank (the issuing bank) pays the letter of credit to the seller and debits the buyer’s bank account.

Documentary letter of credit is beneficial for both parties:

For the letter of credit applicant (buyer):

• Knowing that goods are dispatched before payment
• Minimising the commercial risks by defining letter of credit terms and conditions
• Better price can be negotiated when providing high-quality payment security for the trade partner
• Motivation for the seller to deliver within the agreed time and in accordance with the other letter of credit terms and conditions

For the letter of credit beneficiary (seller):

• Guaranteed payment for delivery of goods or services when the letter of credit terms and conditions are met
• Certainty that the amount will be paid when the predefined terms and conditions are met
• Better liquidity – the seller can receive funds immediately if the receivable is sold to a bank (for transactions with deferred maturity)
• High-quality letter of credit can be used as a guarantee for seller’s own suppliers