Letter of Credit Agreement
It is an arrangement whereby the bank opening the credit, upon the client’s request and instructions, undertakes payment to a third party (the beneficiary) or to their order, or pays or accepts commercial documents drawn by the beneficiary, or authorizes another bank to execute such payment, acceptance, or negotiation of documents, in exchange for specified documents that comply with the terms of the credit.
Importance of Documentary Credit for the Exporting Seller:
The seller is often hesitant to ship goods to a buyer whom he does not know and whose financial solvency is uncertain before receiving payment. Likewise, the buyer may hesitate to send payment before receiving or shipping the goods.
Therefore, the bank intervenes by opening a documentary credit on behalf of the buyer, replacing him in paying the value of the goods to the seller upon presentation of documents to the bank.
Importance of Documentary Credit for the Importing Buyer:
Through obtaining a bank undertaking to pay the price of the goods to the seller, the buyer is not required—at the time of concluding the contract or before shipment—to pay the price, and he may not even have the financial ability to do so.
When the bank pays the price, it receives the documents representing the goods. The bank’s examination of these documents requires high accuracy and expertise, which the buyer often lacks. This reassures the buyer that the goods will comply with the agreed conditions as reflected in the documents.
Importance of Documentary Credit for Banks:
Opening documentary credits is an important source of income for banks, whether for the issuing bank, the advising bank, or the paying bank in the seller’s country. It generates multiple banking operations such as credit, payment, collection, and other services.
It also provides security for the bank to recover its rights through holding the documents of the goods, effectively treating them as collateral. Based on these documents, the bank receives the goods and may sell them at public auction.
Furthermore, the insurance policy issued for the goods enables the bank to claim compensation from the insurance company in case of loss or damage to the goods.
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