A documentary letter of credit is a guarantee of from the issuer (issuing bank) to the beneficiary that the issuer will pay the beneficiary money when the beneficiary provides certain documents to the issuer in a certain manner time and place.
A documentary letter of credit is issued by a bank or a financial institution. The letter of credit assures the supplier (beneficiary) that they will receive payment up to the amount stated in the letter of credit, provided that the beneficiary makes a compliant document presentation.
Once the beneficiary makes a compliant presentation, the Issuing institution will make a payment. Even if the buyer (applicant) cannot pay for the beneficiary's services, the issuer is obliged to honor the presentation.
Documentary letters of credit are mostly used in international transactions, where the buyer and seller have yet to establish a strong relationship and/or operate in different countries. When concluding a deal with a buyer from a different country, the seller is exposed to risks due to the physical distance between the two parties, foreign or unknown legal systems, and lack of knowledge about the buyer. A seller may be hesitant to enter such a risk-sensitive deal without a letter of credit as financial security.
In these cases the credit worthiness of the issuer stands in place of the credit worthiness of the buyer, giving the supplier greater comfort that he will be paid.
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