Essentially, there are three parties to a letter of credit – the applicant, the issuing bank and the beneficiary.
Applicant is the person at whose request the issuing bank opens a letter of credit. Usually, he is the buyer of goods or services. So, it is for him to give proper instructions to the issuing bank stating the documents against which payment can be made to the beneficiary. He also has to give a suitable assurance to the issuing bank that in case payment is made against presentation of documents specified in the letter of credit, he will reimburse the issuing bank for the amount paid.
Issuing bank is the entity that gives an irrevocable undertaking to the beneficiary to make payment of the specified amount upon presentation of the documents mentioned in the letter of credit.
Beneficiary is the person who receives the payment if he presents the documents as specified in the letter of credit.
Other parties can be added as considered necessary to carry out the transaction smoothly.
When an issuing bank sends the letter of credit to its correspondent bank in the importing country and requests it to advise the letter of credit to the beneficiary, the bank acting on such instructions, verifies the authenticity of the letter of credit and then transmits it to the beneficiary, it becomes a party to the letter of credit as the advising bank.
When an issuing bank authorizes presentation of documents under letter of credit to a named bank and requests that bank to receive the documents so presented and that bank agrees to do so, it becomes party to the letter of credit as the nominated bank.
When an issuing bank does not nominate any bank and makes the letter of credit freely negotiable, any bank that gives value for the documents to the beneficiary becomes a party to the letter of credit as the negotiating bank.
When an issuing bank requests its correspondent bank to undertake payment on its behalf against presentation of the documents and the bank acting on its instructions gives such an undertaking, it does so by adding its confirmation to the letter of credit and thus becomes a parry to the letter of credit as the confirming bank
When an issuing bank requests its correspondent bank to, on its behalf, pay the negotiating bank or the confirming bank and that bank so requested agrees to do so, it becomes a party to the letter of credit as the reimbursing bank.
In a transferable letter of credit, when an issuing bank requests and authorizes its correspondent bank to, at the request of the first beneficiary, transfer the letter of credit to a second beneficiary and that bank agrees to do so and acts on the request, it becomes a party to the letter of credit as the transferring bank.
In a transferable letter of credit, when the second beneficiary acquires rights claim payment against presentation of documents specified in the transferred letter of credit, he becomes a party to the letter of credit as the second beneficiary.
It may be noted that some of the banks mentioned above may take on the functions of one or more banks under letter of credit. For example, an advising bank may take on the additional role as the nominated bank and/or negotiating bank and/or the confirming bank and/or the confirming bank.
The Uniform Customs and Practices for Documentary Credits (UCP) published by the Interactional Chamber of Commerce (ICC) clearly spells out the rights and obligations of the parties to letter of credit.