1. The Need for Financing
    The primary purpose of the letter of credit is to pay the seller/beneficiary. Commercial letters of credit are payment mechanisms. However, merchants and bankers realize that the credit is also a source of credit that they can use as support for two transactions: (1) the international sale of the goods itself; and (2) the seller/beneficiary’s acquisition of the goods it is selling to the buyer/applicant or the supplies or raw materials and labour it uses to manufacture the goods it is selling to the buyer/applicant.

  1. Discounting
    The seller/beneficiary may ask the nominated bank to discount the seller’s draft when the seller presents it to that bank and before payment is due under the credit. Often, the value of the paper the seller/beneficiary deposits with the nominated bank induces the nominated bank to grant that credit to the seller/beneficiary. There can be two valuable items in this presentation: the draft itself and the document of title (the combined transport document or port-to-port bill of lading). For a discussion of documentary draft transactions, see chapter VI.

  1. The Draft
    The draft itself is valuable, as, under negotiable instruments law, when the seller/beneficiary draws the draft, the seller/beneficiary undertakes to pay any holder of the draft if the issuer fails to honour it. If the issuing bank dishonours the draft, the holder of the draft can collect from the seller/beneficiary. If the seller/beneficiary’s bank gives value to the seller/beneficiary before the issuer honours and the issuer dishonours, the bank may recover from the seller/beneficiary.
    The nominated bank will know by looking at the documents and the letter of credit whether the issuer is obligated to honour the draft. With few exceptions, if the documents comply with the conditions and terms of the credit, the issuer must pay. The nominated bank will therefore often give the seller/beneficiary value.

When the seller/beneficiary draws under a usance or time documentary credit, the draft is a usance or time draft, and, if the documents comply, the issuer must accept the draft and create a banker’s acceptance. In some cases, the nominated bank may be authorized to accept the draft. A bank that is nominated to accept drafts and elects to do so takes responsibility for paying at maturity. This is similar to the obligation of a confirmer, but with no commitment in advance to accept the drafts. The decision is based on an assessment of the risk of not being reimbursed by the issuer, as the obligation to pay becomes unconditional once the draft is accepted. Acceptance, whether by the issuer or a bank nominated to accept drafts, is a banker’s acceptance, an investment vehicle so valuable that the nominated bank is able to sell it in the money markets on behalf of the seller or may even buy it itself. Banks often buy their own acceptances, knowing that they represent their own obligations to pay when they come due.
In short, the draft is a valuable piece of paper when it is drawn under a documentary credit and accompanied by documents that comply with the terms and conditions of the credit.


  1. The Document of Title
    The nominated bank may be more willing to give the seller/beneficiary an advance when the seller/beneficiary presents its documents if these documents include a document of title, usually a negotiable combined transport document. When a seller/beneficiary is shipping goods or commodities that have a recognizable market value, say, bauxite or some other regularly traded commodity, the letter of credit can be structured to make the nominated bank the holder of a negotiable transport document covering the ore. In that case, if the nominated bank gives value to the seller/beneficiary, it has a security interest in the ore. If the issuer dishonours the draft, the nominated bank can enforce the transport document by directing the carrier to deliver the ore to the bank’s order and can then sell the ore in the bauxite market.