Risk Analysis in Documentary Letter of Credit Operation

Abstract

Documentary Letters of Credit are among most popular methods of payment used in international trade. They function as an irrevocable promise of issuing a bank to pay instead of an applicant buyer to a beneficiary seller under the condition that the beneficiary presents complying documents with terms and conditions of the credit to the bank. One of the reasons for the popularity of the LCs in international trade is shifting the payment risk from an individual buyer to a bank with a much stronger financial standing. However, LC operation in international trade is not free of risk. Despite the fact that two main principles of the Documentary Letter of Credit’s Operation (Principle of independence and principle of strict compliance) facilitate the process of international trade significantly, but still all parties involved in LC operation are supposed to be cautious about the existing risks relevant to their role in LC operation. Current paper tries to use legal principles of documentary credits and risk management theory in order to define existing risks to each party (beneficiary, applicant and bank) in international LC transaction and find an answer to the question of what are exposing risks for involved parties? For this purpose, the paper starts with an explanation of the two main principles of LC operation and moves forward with using the risk management theory to explain existing risks for each party in detail.