A guide to using letter of credit for export financing
written by: mrana616
Letters of credit are also called drafts or documentary collections. They are a financial instrument often used in export financing to protect both interests of the buyer and seller. They require that payment to be made immediately or at a later date. Letter of credits paid at a later data are called date drafts, while those paid on presentation are called sight drafts.
For handling letter of credits, banks usually charge fees. In export transactions, it is customary for the exporter to usually expect the buyer to pay the letter of credit charges. The fees for letters of credit can be high relative to the sale, therefore they can be somehow expensive for smaller amounts.
For international traders, letters of credit are considered as one of the most secure and versatile instruments. A letter of credit states the bank’s commitment on behalf of the importer to make the payment to the exporter under the conditions and terms stipulated. These terms and conditions are evidenced by presenting some specified documents.
Among the benefits of using letters of credit are included:
• Letters of credit are highly customizable.
• They enable new trades by reducing credit risk.
• Letters of credit provides the trade partners the ability to enter newly established trade relationships and to quickly expand their business into new territories.
• The issuing bank is independent of the obligations of the trading partners as well as of any arising disputes.
• The credit-worthiness is transferred from the importer to the issuing bank.
• In case that the importer goes bankrupt, letters of credit are safer for the exporter.
• Letters of credit are quick to execute.
• They provide certainty to the timing and amount of the exporter’s cash flows.
As consequence of these advantages provided by this financial instrument, a number of major banks considering loans for exporters based on incoming letters of credit in favor of those exporters. These letters of credits are offered to creditworthy customers that have reasonable sound finances and proven track records.