Commercial Letter of Credit

A substantial volume of foreign trade is transacted on "draft basis," in which the parties to the exchange instrument are the exporter and the importer. A standard and simple transaction on draft basis has been described; the following two chapters will supply the variations. The reader should have observed that when foreign trade is handled in this manner banks may act in either of two capacities, as collectors or as negotiators. There are many occasions in which the strength of a bank's name is used to assist foreign trade. Importing and exporting in this instance is on "bank credit basis" and involves the use of the commercial letter of credit, which may be described as an instrument by which "a banker, for account of a buyer, gives formal evidence to a seller of its willingness to permit him to draw on certain terms and stipulates in legal form that all such bills will be honored" on presentation.

From the viewpoint of a single country, commercial letters of credit may be divided into two groups. If an American importer provides the foreign exporter or shipper with a credit, we would consider it an import letter of credit, since it is being used to finance our imports. To the foreigner it will be an export letter of credit. If an American exporter is provided with a credit by the foreign importer or buyer, we would call it an export letter of credit, since it is being used to finance our exports. To the foreigner it will be an import letter of credit. In the case of either import or export letters, the credit may be in dollars or in foreign currency and may provide either for sight drafts or for time drafts.