A letter of credit is defined as "Letter issued by the importer's bank in favour of the exporters authorising him to draw bills upto an amount specified in it and assuring him of payment against the delivery of the prescribed documents in his own country".

A letter of credit is a guarantee to the exporter that his draft will be honoured by a specified bank upto certain amount. The importer of goods approaches his banker to open a letter of credit in favour of the overseas supplier. The importer is called Opener or accountee. His bank is known as Opening bank. The letter of credit is sent to the foreign branch of the bank (or the correspondent bank). Such bank is called negotiating bank.

Thus a letter of credit is a document or order by a banker in one place authorising some other banker acting as his agent or correspondent in another place to honour the drafts or cheques of a person named in the document, upto the amount stated in the letter.

Uses of letters of credit

1) Letters of credit help international, commercial and social relations.

2) A person who travels abroad need not carry with him any large sums of money.

Letter of Identification

The traveller's letter of credit consists of letter of identification. It ensures safety. It has to be produced each time an amount is drawn in respect of it. The customer puts his signature to the letterof identification in the presence of issuing banker. The foot note required the beneficiary to keep letter of identification apart from letter of credit. This precaution makes forgery and false impersonation difficult. Fundamentally, the letter of identification is a proof for identifying the customer.

A letter of credit carries spaces for particulars such as the date, place of payment, the amount in words and figures paid and the name of the cashing banker. These particulars will be recorded for every withdrawal. The paying bank presents the beneficiary's drafts to the issuing banks and get them reimbursed.

Traveller's letter of credit is issued on the payment of the full amount by the beneficiary. Sometimes, it may be issued against the gurantee of the customer to pay the amount with interest later. Such letter of credit is called gurantee letter of credit.

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