Letters of Credit
What is a Letter of Credit?
A Letter of Credit, is a document issued by a financial institution, or a similar party, assuring payment to a seller of goods and or services provided certain documents have been presented to the bank. In other words is A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.
History of Letters of Credit:
Understanding the nature of letters of credit as an international financial device and the reason why they have become widely used by merchants all over the world requires us to find out its historical origins.
Some scholars believe that the origins of letters of credit go back to ancient Egypt and Babylon, which had an adequate system of banking. A clay promissory note of Babylon dating from 3000 B.C., is exhibited in the University Museum of Philadelphia, USA, which provided for repayment of an amount and the interest on a specific date.
Another discovery is an evidence of an obligation made in 248 B.C. in Egypt “for the repayment, in wheat, or upon default double its value, of a loan of money from one Zenon, which ends with ‘and the right of execution shall rest with Zenon and the person bearing the note on behalf of Zenon". It is also verified that banks of ancient Greece prepared letters of credit “on correspondents with the view to obviating the actual transport of specie in payment of accounts”.
With the collapse of the Roman Empire the role of the banks as well as the great extent of commerce between trading nations diminished. It was not until the 12th and early 13th century that banks in Genoa, Venice, Florence and other European cities were re-established. At this time merchants had to face two major problems:
(a) travelling with gold was very dangerous.