A letter of credit is a legal, written document that guarantees the buyer’s timely & full-fledged payment to the sellers. The buyer’s bank issues it to compensate the seller if the buyer defaults or cannot pay the seller. In such cases, the bank covers the full or remaining amount on behalf of the buyer.
In other words, an international letter of credit service is a legally-binding finance instrument issued by a bank or trade finance institution to ensure on-time payments for the goods received on behalf of the buyer. It is also known as a Documentary Credit, where if any buyer fails to perform their due obligation, the bank pays the seller on behalf of the buyer, who then repays the bank later.
Issuance of a letter of credit helps reduce the payment failure risk for the seller as it shifts from the buyer to the bank. On the other hand, it also allows the buyer to make an early payment to the seller, improving his credibility in the market.
If you are an importer or exporter involved in international trade, you may have worked with a letter of credit. It is one of the most frequently used trade finance instruments that bridge the gap between a buyer & a seller as well as eases the payment transaction in a trade transaction.
Here are a few tips for both the importers & exporters while choosing a global letter of credit service. Take a look:
1. While requesting an LC service, importers should consider the standard & most used payment methods in the exporter’s country to pay him for the goods received.
2. The imports should ensure that the concerning LC is issued with mentioning all the details of the purchase precisely & correctly. It is recommended to consult with a financial advisor or approach a bank that provides trade finance service to importers/exporters. Their finance team consists of trade experts with valuable banking experience.
3. If necessary, the importers should carry out re-negotiation or alter/amend the terms of a letter of credit with the exporter. Choosing an irrevocable letter of credit is recommended for performing a risk-free trade transaction globally.
4. The importers may reduce the foreign exchange risks by purchasing currency contracts.
5. While choosing an import finance service, keep in mind that the contracts of purchase & other agreements relating to the transaction with the seller are not concerned by the issuing bank.
6. The validity period mentioned in the LC document should be enough for the exporters to produce the goods or supply them from the stock.
7. The documents mentioned in the Letter of credit should also include those required by the importer at the time of customs clearance.
8. An International letter of credit service provider does not take the guarantee for the goods shipped, rather only responsible for the documents of proofs like Bill of Lading etc. It means that the issuance of a letter of credit cannot be turned down on the grounds that the goods were not delivered as described in the contract.
1. Before signing a trade agreement with the buyer, the sellers should conduct a thorough background check on the buyer’s credibility & financial status along with the business practices.
2. Exporters should always go for irrevocable global Letter of credit service.
3. The exporters should also ensure that the bank providing an export finance service is financially sound, as they may reject an LC request on the grounds of various financial issues.
4. The exporters should also ensure that all the terms & conditions mentioned in the contract are correct. Review the LC documents correctly.
5. If there are amendments required, the exporters should approach the importers so that they can instruct the issuing bank and carry out the necessary changes.
6. The exporters should also verify with the insurance company the amount of coverage mentioned in the documentary credit.
7. Also, exporters should check if the goods specified in the LC contract are the same as those specified in the invoice.
8. The exporters should also know the foreign exchange limitations in the importer’s country, which could impact the payment procedures.
After thoroughly reviewing a letter of credit, both the importers & exporters can proceed with the shipment. LCs are the most used & globally accepted trade finance instrument. Keeping these precautions & considerations in mind, the parties to the transactions can avoid several issues. LCs can be complex but can provide the ultimate benefits if used correctly.