A documentary letter of credit is issued by a bank or a financial institution. The letter of credit assures the supplier (beneficiary) that they will receive payment up to the amount stated in the letter of credit, provided that the beneficiary makes a compliant document presentation.
Once the beneficiary makes a compliant presentation, the Issuing institution will make a payment. Even if the buyer (applicant) cannot pay for beneficiary's goods and/or services, the issuer is obliged to honor the presentation.
Documentary letters of credit are mostly used in international transactions, where the buyer and seller have yet to establish a strong relationship and/or operate in different countries. When concluding a deal with a buyer from a different country, the seller is exposed to risks due to the physical distance between the two parties, foreign or unknown legal systems, and lack of knowledge about the buyer. A seller may be hesitant to enter such a risk-sensitive deal without a letter of credit as financial security.
In these cases the credit worthiness of the issuer stands in place of the credit worthiness of the buyer – giving the supplier greater comfort that he will be paid.