Import Letter of Credit - is your bank giving you a fair deal?

Richard Casburn, Training Partner of MJ Hayward Associates, answers a recent question raised by a bank client seeking a facility to issue Letters of Credit to overseas suppliers:

Q. 

"We are an established company and we import a variety of finished goods from suppliers in China, India and Vietnam. In most instances our suppliers require settlement by Letters of Credit payable at Sight. We have an Import Letter of Credit facility with our bank which works reasonably well. However, on speaking to a competitor at a recent networking event, I was advised that his bank are prepared to "risk weight" his Letter of Credit facility. He explained that this meant that his bank are prepared to actually take into account the value and nature of the goods when deciding on the level of security they  need to support the facility. Our bank requires us to cover 100% of the value of the facility with tangible security.

Is this usual and could I negotiate a better deal in terms of securing my facility with my bank?" 

A. 

An Import Letter of Credit constitutes a definite obligation for the issuing bank to pay against presentation of compliant documents regardless of whether it is able to reimburse itself from the applicant. So the majority of Banks will see this as a commitment which represents a 100% risk, and they will therefore require security/collateral which will equate to that value.

In the scenario in the question, it would be reasonable to ask the customer's bank to consider risk weighting the facility. In simple terms this means that the bank would give consideration to the nature of the goods, and most importantly that the bank will have control of the goods during the course of the Import Letter of Credit transaction.         

A bank will always look "worst case", and this would involve taking delivery of the goods and appointing a third party to realise some value in a forced sale situation. Therefore there are many considerations for the importer's bank to evaluate including;     

• Obsolescence - What is the likelihood of the goods becoming obsolete and therefore very difficult to sell, unless they are imported and sold quickly?

• Perishability - Does the product set have a shelf life? Food or fresh flowers for example would not be attractive goods for a bank to consider risk weighting in a Letter of Credit facility.

• Packing - Is special packing required?, e.g. refrigerated container

• Marketability - Is there a strong demand for the products. The bank is thinking that in a worst case scenario how easy would it be to sell these items?  

• Does the Letter of Credit call for a full set of Bills of Lading, and if so, can they be consigned to the issuing bank which will provide extra control over the transaction. If goods are shipped by air, the airway bill will almost certainly be required to be consigned to the issuing bank.

• What is the margin of profit on the goods and are the goods presold against confirmed orders?

• What are the Incoterms - are goods adequately insured? In some instances a bank may insist on holding the original insurance policy as a security item.

• Speculation/overtrading - Does the Letter of Credit facility requested reflect the customer's normal trading patterns? The bank may be concerned that a customer is attempting to stockpile goods to take advantage of price fluctuations which could potentially have serious implications for the business if the market for the products crashed. 

• Storage - is there appropriate and sufficient storage for the goods when they arrive in the UK? Who owns the warehouse? Is insurance adequate? In some instances a representative of the bank may actually inspect the warehouse to ensure that it meets with the bank's expectation in terms of security etc.

• Import License - Certain goods may require the issue of an import license and the bank may required confirmation of this prior to the approval of a Letter of Credit facility.

• Fluctuating price - a long delivery cycle increases the risk that a sudden fall in price may render the goods undesirable or worst case loss making.

If all these considerations and risks can be considered and mitigated then a number of UK banks will be prepared to offer an Import Letter of Credit facility which is "risk weighted" and does take into account the above mentioned factors. The weighting will reflect the potential loss the bank would suffer upon default after recovering funds from selling the goods. Therefore a 20% risk weighting, which is in most instances the very best that any UK bank would consider, implies that the bank would recover £0.80 for each £1 of value of goods. In reality this is very rarely the case in a forced sale situation. It is more likely that a 50% - 75% weighting may be applied, but clearly this would be assessed on a case by case basis, as the factors are varied and open to interpretation by the bank's Trade Finance representative. The bank may require the customer to sign what is called a General Pledge. This is an undertaking whereby the customer acknowledges that the goods and or documents of title to the goods will be in pledge to the bank.

In summary it is well worth asking your bank whether they would be willing to consider this, as most will allocate a 100% risk weighting, which is in effect an easy option for the bank, and does not accurately reflect the actual risk.     

Import Letter of Credit Training