CHAPTER V

TRAVELER'S LETTERS OF CREDIT

The letter of credit has thus far been considered solely as an instrument for facilitating the import and export of merchandise. In addition to the commercial letter of credit, there is another instrument known as the traveler's letter of credit which, as the name implies, serves as a means of furnishing the holder with funds at various places on a journey. The commercial and traveler's letters of credit have certain features in common, and are often taken one for the other. In order to draw a clear distinction between these two instruments, this chapter will explain the meaning and classification of the traveler's letter of credit, the parties involved, and the methods of opening and using it. Throughout the study traveler's and commercial letters will be compared for points of similarity and difference.

I. Meaning.—Assuming that a tourist is setting forth on a trip to Europe, let us trace the various ways in which he may finance his journey which he estimates will cost him about $5,000. He may draw this amount from his bank in cash, either in dollars or in the currencies of the countries which he intends to visit, and carry it with him on his trip. In so doing, however, he incurs the risk of losing it or having it stolen. In order to avoid this possibility he may maintain the $5,000 as a deposit with his New York bank and simply draw checks against the amount. But here again he would probably encounter difficulties in having these checks cashed in a foreign country where he could not well prove either his identity, the genuineness of his signature or the amount of his balance as credited with the bank. These difficulties are overcome by the use of the traveler's letter of credit. In this document a bank formally states that the traveler is authorized to draw on it, or on a foreign correspondent or a branch, sight drafts which one or more of its correspondents or branches will freely purchase with the full assurance that these drafts will be paid when presented at the drawee bank.

II. Classification.-The classification of the traveler's letter of credit is less complicated than that of the commercial letter of credit. The former does not involve the shipment of merchandise, and so payment of the drafts is not conditioned upon the presentation of any bills of lading or commercial invoices. Consequently the traveler's letter of credit is never documentary but always clean in the sense that it authorizes the drawing of drafts unconditionally. These, moreover, are never time but always sight drafts, and so a traveler's letter represents not an acceptance but a cash credit. A traveler's letter of credit cannot be transferred, for it can be availed of only by the beneficiary himself. No advantage would be derived from a transferable traveler's letter of credit for, under the ordinary form, the holder is able freely to deliver any part of the credit to another person by merely drawing a draft for this amount and, upon receiving the cash, simply giving it to the other party.

Traveler's letters of credit cannot well be grouped on the basis of conditions as to cancellation, for the party opening the credit is at the same time the beneficiary or closely associated with him. A traveler's letter of credit can be canceled by no one but the beneficiary himself, and he would take this action only if he no longer desired to avail himself of the credit, or if he desired. to prevent its misuse by someone who may have wrongfully come into possession of it. There is little need of classifying traveler's letters of credit according to place, for they are used mainly by persons traveling in foreign countries. For a trip within the United States the ordinary check, or the traveler's check, is sufficient to meet all necessary disbursements. In short, traveler's letters evidence clean, cash, non-transferable, foreign credits.

Traveler's letters of credit may well be grouped according to the currency in which the drafts are drawn. The New York bank may issue the letter in dollars and so the drafts are drawn on the bank itself. In the case of a sterling credit, the drafts. are drawn on a correspondent bank or branch office located in London. In like manner, credits may authorize payment in francs or marks.

The method of negotiation also determines the classification of the traveler's letter of credit. The issuing bank may address the letter of credit to but one bank, which alone has the right

to negotiate the drafts of the beneficiary. This type is known as the "specially advised" letter of credit. Most letters of credit are "circular" in the sense that they are addressed in general to correspondent banks all of whom may cash the drafts of the beneficiary.

III. Parties.-A firm may open a traveler's letter of credit in favor of a salesman or representative who is going abroad. More usually the prospective traveler opens the credit for himself, and so the opener is at the same time the beneficiary of the credit. The other parties to a traveler's letter of credit are in about the same relation to one another as in the case of a commercial letter of credit. In the first place the bank issuing the letter of credit usually authorizes the beneficiary to draw the drafts on the bank itself, as in the case of a New York institution issuing a credit in dollars. If the letter of credit calls for payment in pounds sterling or in some other foreign currency, the drafts are then drawn on an institution other than the issuing bank. An exception arises where a bank is able to authorize drawings on one of its own branches located in London, Paris or Berlin. The traveler's letter of credit necessarily involves a negotiator who purchases the drafts of the beneficiary. The parties to a traveler's letter of credit therefore are (a) opener and beneficiary, (b) issuer, (c) drawee, and (d) negotiator.

IV. Direct Opening of Credit.-A tourist desiring a traveler's letter of credit applies to a bank in much the same manner as in requesting a commercial letter. The applicant fills out a blank form which calls for such information as name of beneficiary, amount of credit, date of expiration, and terms of payment. In the case of a "cash" credit, the applicant pays in money or by check for the total amount of the credit if in dollars; or, if in foreign currency, for the equivalent in dollars at the current selling rate of exchange for bankers' checks on London, Paris or Berlin. The entire transaction can be compared to the depositing of cash by the customer who in return receives credit for the amount on the books of the bank. Against this deposit credit the customer has the right to draw drafts. Deposit credit in domestic bank operation can be created not only by the customer leaving cash with the bank, but also by the bank extending credit in making a loan to the customer. Likewise, a traveler's letter of credit may

be the result of a procedure which is quite similar to a loan by the bank, as in the case of a "guaranteed" letter. In this type, the issuing bank does not receive payment from the opener for the full amount of the credit but obtains reimbursement only as it pays the drafts drawn by the traveler and presented by the negotiating bank. As a loan may be either secured or unsecured, so a guaranteed credit may be based in the one case on collateral and in the other on a mere promise of the applicant to place the bank in funds when the occasion for doing so arises. While in the case of a cash credit a simple application is sufficient; for a "guaranteed" credit it is necessary for the applicant to sign an agreement. By the terms of this contract, the applicant agrees to repay the bank for all its disbursements under the letter of credit, and to assure the performance of his obligation he pledges certain approved security, such as marketable stocks and bonds. He agrees to maintain these securities at a sufficient margin above the amount of the credit and, in the case of depreciation, to furnish additional collateral.

A "guaranteed" traveler's credit, as mentioned above, may also be unsecured, as when it is based merely on the written pledge of the beneficiary that he will reimburse the bank for all its outlays. A request for this type of a traveler's credit is considered in the same manner as an application for an unsecured loan, and it is necessary for the credit department first to determine the applicant's standing. If it is satisfactory, he is given the credit on signing an agreement or guaranty.

V. Indirect Opening of Credit.-Thousands of small banks throughout the United States have so little foreign business within the year that it is not worth their while to maintain correspondent relations abroad. These banks are therefore unable to issue traveler's letters of credit directly, but they perform this operation indirectly through a city correspondent with established connections in foreign countries. The city correspondent supplies the interior bank with a batch of letters all ready for use on the strength of a trust receipt signed by the latter institution. In this agreement the interior bank acknowledges the receipt of the letters and promises to assume full responsibility for these instruments. The city bank usually protects itself against over-issue by writing upon each letter of credit the

statement that the amount must not exceed a certain maximum limit, say about $2,500. Whenever the interior bank issues a letter of credit on the request of a local customer, it immediately advises the city correspondent and forwards specimen signatures of the prospective traveler.

VI. Form of Letter.-Traveler's letters are issued by banks in forms which are somewhat varied, but they do not present the same lack of uniformity to be found in commercial letters of credit. As indicated above, the traveler's letter contains a request that the drafts of the beneficiary be cashed and an undertaking that these bills will be honored by the issuing bank. The letter is sometimes printed as a large folder which contains a list of the bank's correspondents who will cash the drafts of the beneficiary. At times a specimen of his signature also appears in the lower left-hand corner of the letter as a means of enabling the negotiating bank to identify the handwriting of the true beneficiary of the drafts. This type is quite convenient, furnishing a complete document, including the letter of credit, the list of correspondents and the signature of the beneficiary. On the other hand, this form is quite open to misuse, for if it falls into the hands of the wrong party, he may imitate the signature found on the letter, and present it together with forged drafts to one of the correspondents whose names appear on the attached list. In order to reduce the possibilities of fraud, banks generally issue a separate card of identification, or "letter of indication" as it is called, containing the signature of the beneficiary and the list of correspondent banks. This document may be in the form of a large folder or a small booklet. The beneficiary is asked immediately to sign his name, and is advised to carry the letter of indication separate from the letter of credit proper. Since one instrument is the complement of the other and since both are necessary to enable the holder to negotiate drafts, the possession of either one alone by the wrong party would not allow the fraudulent cashing of drafts. The reverse side of the letter provides space in which the negotiating bank enters such details as date when the drafts are paid, by whom they are paid, and the amount in words and in figures. These entries are essential in order to prevent the beneficiary from drawing drafts in excess of the total amount of the credit.

VII. Operation of a Traveler's Credit.-The traveler arrives