Letters of Credit - what are the benefits?

Documentary Letters of Credit are effective in mitigating the commercial and financial risks associated with trading internationally and are beneficial to both exporters and importers.

Advantages to the Exporter 

- Where there is no existing relationship with a customer, a Letter of Credit provides an assurance of payment from an independent party (ie: the bank), subject to conditions being met.

-  Opens the door to new or potentially difficult markets (eg: where unstable economic or political conditions exist), particularly where a nominated bank in the exporter's country is prepared to add its confirmation that payment will be made.

- Payment is guaranteed upon presentation of conforming documents to the bank. Banks deal in documents and are not concerned with the goods, services or related performance of the exporter (article 5, UCP 600).

- Predictability of cash flow. The structure of a credit includes timeframes for shipment and subsequent presentation of documents, therefore the exporter can be fairly certain when payment will be effected (subject to compliance with the terms and conditions). The bank may also be prepared to negotiate / discount the value of the documents presented under ‘term’ or ‘usance’ Letters of Credit.

- A structure / framework within which payment is triggered. The skilled exporter will provide copies of the credit to all interested parties / departments, including the freight forwarder with clear instructions with regard to accurate preparation and disposal of documents.

Advantages to the Importer

- Stipulates the terms and conditions which make it more likely that goods will be received in order and on time.

- Removes the need to release cash in advance to the supplier, thus reducing the risk of non-delivery or delayed delivery of the goods.

- Predictability of cash flow. By stipulating a period for shipment and subsequent presentation of documents, the importer can be fairly certain when payment will be triggered.

- By providing the supplier with a Letter of Credit, the bank is guaranteeing payment (subject to compliance with the credit terms) and therefore the importer could request longer periods of credit to finance the transaction.

- Banks may be prepared to finance greater amounts for longer periods under Letters of Credit as opposed to overdraft, due to heightened visibility and knowledge of the transaction.

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