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What is a Letter of credit?

Letter of credit

A letter credit is a letter from the bank that ensures that the buyer pays the amounts owed by him to the seller on time and in the correct amount and guarantees the receipt of the goods in compliance with the required specifications. In international trade, due to the nature of international transactions and other factors such as distance and the laws of different countries, and it is a negotiable instrument, the issuing bank pays the beneficiary or any bank that nominates it. The use of letter credit is widespread in import and export due to the difficulty of obtaining confidence between the parties. The credit is a guarantor for both parties to trade.
What is a Letter of credit?
What is a Letter of credit?

Letter of credit Parties and Terminology

Credit in the modern era is considered a mainstay of international trade, and letter credit is not limited to the importer, the exporter and the bank, it may contain several parties, and the terminology of letter credit is not limited to accounting and economics, it may be between law and banks, but it is commercial in general. The letter of credit, the approved bank, the shipper, the freight forwarder, etc., and the following is an explanation of what a letter of letter credit may include:
  • Applicant: The party who requests the letter of letter credit from the bank and uses the credit to make the purchase.
  • Beneficiary: The party receiving the payment, usually the seller or exporter.
  • Credit-issuing bank: It is the bank that issues a letter letter of credit at the request of the applicant.
  • Negotiating Bank: It is the bank that works with the beneficiary, and the negotiating bank acts as a link between the beneficiary and the other concerned banks.
  • Advisory Bank: It is the bank that receives the letter of credit from the issuing bank, and it may be the negotiating bank and the confirming bank.
  • Broker: A company that links the importer and the exporter.
  • Freight forwarder: A company that helps with international shipping, and freight forwarders provide documents that exporters need.
  • Shipper: The company that transports goods from one place to another, and may be the same as the freight forwarder.
  • Legal Counsel: A firm that advises applicants and beneficiaries on how to use letters of credit.

Types of letters of credit

Letter credit is an important guarantee for the importer and exporter, especially with international exchanges, and it is a form of payment insurance from a financial institution or another party approved in the transaction, due to its importance and the different laws between countries and the need for it from one beneficiary to another. And other types, which are as follows:
  • Commercial letters of credit: They are prominent in the completion of international trade The International Chamber of Commerce has published Standard Customs and Practices for Letter Credits which comply with most commercial letters of credit.
  • Standby letters of credit: They work a little differently than most other types of letters of credit. If a deal fails and a party is not compensated as it should have been, the beneficiary can prove that he did not receive the payment and uses this more as security and less as a means of facilitating the exchange.
  • Revocable Letters of Credit: Legally contractual for one of the parties to either modify or cancel the exchange at any time and without the consent of the beneficiary, it creates leverage for the issuer.
  • Irrevocable Letters of Credit: No amendments or cancellations can be made without the consent of all parties involved.
  • Periodic Letters of Credit: A letter credit that is designed for multiple uses as it can be used for a series of payments, and is common among individuals or companies that expect to do business together on an ongoing basis.
  • Red Statement Letters of Credit: Contains an unsecured loan issued by the buyer that serves as an advance on the remainder of the contract.
  • Approved: Each letter letter of credit that is written in an official document agreed upon by both parties prior to submission to the guarantor financial institution for review.

Historical development of letter credit

The historical development of letter credit has been linked to the development of commercial law. The letter credit is a letter of guarantee for both parties to trade and the commercial law has been striving since its establishment to guarantee trade rights. It was also associated in the past with marine insurance, where international trade was limited in the past to maritime trade and merchant ships and a proposal for the historical development of credit The document is as follows:


The most prominent of which is the rule set by the Phoenicians, navigators on the sea, which states that the losses incurred by a sea captain as a result of trying to save ships and cargo from dangers must be shared by all owners of goods and the owner of the ship. For a commercial sea voyage, the loan is secured by the ship and the goods, and the repayment of the capital and the payment of interest are conditional on the safe return of the ship.

Roman era

The most important characteristic of it is the enactment of a commercial law, the commercial law of the Romans was known, and a separation arose between the ordinary civil law and the rules for foreign relations, and from the rules of law that the seller could cancel the sale if the price paid for him was less than 50 percent of the value of the goods sold.

middle Ages

Churches forbade taking interest for loans, and an attempt was made to popularize the idea of ​​a fair price. Law and economics were affected over the centuries. Also, a separate commercial law such as the Law of Affiliation was developed in the early Roman days and these rules were promulgated and enforced in special courts conducted at the numerous international fairs that were held In various Europe, corporate law and banking law developed where bills of exchange were used partly for the transfer and exchange of money, partly for payment and partly for credit purposes.

French Revolution

After the Middle Ages and before the French Revolution, commercial transaction law lost its global character, and the law was nationalized in 1673, and in England the legal merchant was mixed in common law, and the so-called colonial companies appeared, and the responsibility of each member was limited to his contribution, which was represented by share certificates that were transferable In 1807, the French King Louis XIV issued Laws on Land and Maritime Trade that set the pattern for the national codification of transaction law.

Twentieth century

Domestic trade and international trade expanded and major and regional corporations and joint stock companies emerged, which led to an urgent need for legal certainty, especially for transnational transactions, which led to the standardization of contracts. Trade associations as well as individual institutions developed standard contracts as well as shipping transactions, which helped bridge the gap between Many different national rules, unified legislative rules for international transactions were also established and international agreements led to the unification of many rules and the emergence of letter credit in all its forms.

Letter of Credit Financing

Banks usually require a pledge of securities or cash as security for the issuance of a letter letter of credit or a credit covering the credit in the account and banks charge a fee for this service, usually a percentage of the size of the letter of credit. used in international transactions.
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