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Letter of Credit

Updated on December 25, 2009

A Letter of Credit is an authority from a bank addressed to a specified agent in the case of a direct letter of credit or to their agents generally, in which event it is termed a circular letter of credit, requesting them to honour the draft presented for payment by the person named therein provided the terms stated in the letter of credit are fully observed. A documentary letter of credit will require documents such as invoices, bills of lading, and insurance certificates to accompany the draft when presented for payment and is used extensively for the settlement of international trade debts. Under a clean letter of credit no document other than a draft is required and this type is especially suitable for use by a person travelling abroad.

He need start his journey with cash sufficient only to defray his immediate expenses on arrival at his destination and thereafter can obtain funds through his letter of credit as and when and where he requires them up to the total specified in it. An integral part of such a letter of credit is another document called a letter of indication. This is issued to the beneficiary at the same time as the letter of credit and bears a specimen of his signature for identification. To guard against the possible results of loss or theft, the two documents should not be kept together since either is valueless without the other. Each withdrawal made is recorded on the letter of credit which is finally retained by the paying agent w:hen the total sum authorised has been drawn. A letter of credit is not transferable and is issued for a limited period only, usually not exceeding 12 months. It is generally issued for a much larger sum than are, e.g., traveller's checks.

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