Including a letter of credit as the method of payment in the terms of a contract is justified if the exporter requires, in addition to the contractual obligations of the importer, the payment obligation of a third party. Using a letter of credit is preferable if there is any doubt concerning the importer’s solvency or the stability of the political or economic situation, or if there are any currency (exchange rate) limitations in the buyer’s nation.
The advantages of a documentary letter of credit:
- It is an independent transaction containing both a clear-cut payment obligation to the benefit of the exporter and the opportunity for both importer and exporter to raise credit.
- The credit-standing and reputation of the bank that issues the letter of credit is to the benefit of both parties.
- It eliminates the buyer’s default risk, since the payment against documents provided for under the terms and conditions of the letter of credit is guaranteed by the bank that issued the letter of credit. At the same time, receipt of money by the seller does not depend on the buyer’s willingness or ability to pay.
- It implies that an unbiased and thorough verification of the documents, on the basis of which payment is to be made, has been carried out by competent bank experts.
- It is subject in most nations to the Uniform Customs and Practice for Documentary Credits of the International Chamber of Commerce.
- It reduces individual currency and political risks.