Royal Bank Pacific - Letter of credit

When we make a promise to someone we make sure to deliver it whether it is a service to be provided or a product to be delivered. But there is no assurance of its completion except a mutual understanding and one’s conscience to do what is promised.

Now imagine a scenario where money is involved. Things get a little more complicated when it is a matter of monetary transaction. One doesn’t simply make a deal on a verbal promise to pay. Something more concrete is required. 

There are many institutions dealing with money nowadays. The most common are the banks. Banks deal with a number of accounts, transfer of funds, deposit and withdrawal of cash, savings of its customers, loaning services etc. Can a bank make all these transactions on a verbal promise? Will you trust a bank with your money with no legal compliance? No, right?

so there are various legal documents required to carry out such transactions.  Imagine making a sale with a client and not being paid for it. To avoid such a contingency there is a document that assures you the payment for your sale. It becomes essential to make use of such a document when the parties to contract are not known to each other or are from different countries having different legal procedures. It is the Letter of Credit. 

Now what exactly is a letter of credit. It is a letter issued by the buyer’s bank to promise to pay to the seller in lieu of the purchase made by the buyer. It is a promise made by the bank of the buyer to make the payment on the behalf of the buyer in case the buyer is unable to pay.  

The bank or the financial institution acts as a middleman between the buyer and the seller and gives the assurance of making the payments on the compliance of certain obligations. The letter of credit works not only in the international trade but also domestic trade. There are certain terms and conditions that need to be complied with in order for the issuing bank (buyer’s bank) to be obliged to make the payment. These terms and conditions need to be complied with by both the parties to the contract ,i.e, the buyer as well as the seller, in accordance to its presence in the letter of credit. 

One thing to be understood before knowing about letter of credit is that the bank or the financial  institution liable to make the payment investigates the ‘documents’ and not ‘goods’ to abide by the contract.  

The letter of credit is widely used for various financial transactions as it proves to be beneficial for both the parties to contract. It benefits the seller as the risk of non-payment for the goods or services delivered is eliminated as the seller is assured by the bank to be paid in case of non-compliance by the buyer.  And it benefits the buyer as the chance of pre-payment can be reduced or avoided.