COMMERCIAL LETTERS OF CREDIT Nature of Commercial Letters of Credit In commercial language, a commercial letter of credit entitles the taker, or a third party, to " commercial credit," " banker's credit," or "acceptance credit," as it is variously called, at the issuing bank or its correspondent. A commercial letter of credit is a grant by letter or cable authorizing an individual or firm to draw drafts on the issuing bank or its correspondents, for its account, under certain stipulated conditions. The letters are used: 1. To finance transactions involving the exportation and importation of merchandise, that is, to finance the production, transit, and marketing of goods for export and import.
2. To finance the domestic shipment of goods, against ship ping documents covering goods in transit.
3. To finance the domestic storage of readily marketable staples in warehouse.
Domestic credits are not intended by the Federal Reserve Act to finance the production of goods. An export or import credit is in effect a guaranty by the bank to the seller of mer chandise that his drafts covering certain merchandise and drawn in accordance with the conditions prescribed in the credit will meet with due honor on presentation to the accepting bank named in the letter of credit.
The general nature and uses and the legal phases of commer cial letters of credit and banker's acceptances have been pre sented in Volume I, Chapter IX, and Volume IV, Chapter L, and also in the present volume, Chapter LIV. In these chapters it is shown that the use of such instruments is one of the methods by which a bank extends its credit; that they are designed to provide short-term, as against long-term, credit; that they are designed to supply an assured credit for carrying goods in stor age, production, transit, and marketing; that they should cove: essentially self-liquidating transactions; that the banker should retain, ordinarily and as far as practicable, the control over the goods, and should receive and apply the proceeds to the retire ment of the bills when due; and that the maturity of the bills drawn under the credit should synchronize with the prospective liquidation of the transactions.
Advantages of Their Use The advantages of the use of letters of credit are numerous. The most important benefit to the seller of the merchandise is that he is authorized to draw against a well-known bank instead of against the less known importing house. This enables the drawer to command a better price for his draft, as it is a banker's prime bill instead of the more risky commercial bill; and since the drawer is able to convert his draft at a good price and at any time, he enjoys a competitive advantage over those who do not use bankers' credits. Other advantages are that the buyer of the goods is not required to make payment until maturity of the draft and can often realize on his purchase before the acceptance falls due. The bank which issues the credit is in a position to weigh the credit title of the buyer and, if the circumstances war rant, to turn over the documents (virtually, the goods) in ad vance of payment. The buyer is, therefore, able to do more business on his capital. The fact that the bank grants credits to the buyer of the goods usually indicates that he enjoys a high standing in the business world. The general result of these facts is that, by the reduction of risks, business can be more freely transacted and on a lower price basis.
Another advantage arising from the use of bank credits is the greater liberality extended by law to this kind of financing. Prudent banking practice and banking laws have drawn a dis tinction between money borrowed and bankers' acceptance credit. The amount of the loans a bank may make to one per son, firm, or corporation is specifically limited to a percentage of the capital and surplus of the bank; but there is no limitation to the amount of accommodation that may be granted by a national bank to one customer through discount of commerdal paper actually owned by him.