What Is a Sight Letter of Credit?

A sight letter of credit makes drafts drawn on it payable by demand, as soon as the draft and supporting materials are presented to the issuing bank. This contrasts with a time letter of credit, where banks have a set period of time to review documentation before they provide a payment. The advantage to a sight letter of credit is the ability to instantaneously access funds, while the disadvantage is that banks may expose themselves to risk by paying on demand, without time to review the paperwork. Many banks offer this type of credit, particularly if they specialize in international trade and related financial activities.

Before a bank will issue credit to a customer, it usually requests supporting information to determine whether to grant credit, and how much to provide. Companies usually need to make records available to allow the bank to determine how much they take in during a given year and what kinds of existing expenses and debt obligations they have. Companies may also need to show that they have established business relationships, are unlikely to renege on credit, and are confident that their products will sell, ensuring that payments will arrive to pay off loans extended against the letter of credit.

The bank determines the terms and conditions of the sight letter of credit. Typically the account holder must issue a draft for payment, which the beneficiary presents along with documentation like bills of lading. The terms should clearly indicate which documents are needed for a payout against the site letter of credit. Companies that work with shippers, expediters, and other third parties need to make sure they know what kind of documentation to issue so that sellers get paid.

When a seller approaches a bank with a draft drawn on a sight letter of credit and the documentation, a bank official can review it, confirm the validity, and authorize a payment. This task may be performed by the seller's bank or agent, rather than the seller personally. If the documentation is not in order, the bank can refuse the draft and request the correct paperwork. As long as it appears appropriate, the bank must issue the funds immediately, and cannot hold the papers or delay payment.

Letters of credit are key to trading activities around the world, where buyers and sellers need to connect and may not necessarily have complete trust in each other. The sight letter of credit provides an assurance of immediate payment for products and services, which may be advantageous for some sellers. For banks, it can create a risk, as forged, falsified, or otherwise altered drafts and documentations may be accepted at face value, allowing the bank to make an irrevocable payment that it cannot take back if there is a problem with the transaction.