Problems with Letters of Credit

What are the problems with Letters of Credit?

There are a number of difficulties with using a Letter of Credit, but they are one of the most widely used instruments for trade. Letters of credit are used in 11-15% of all global export transactions, accounting for over a trillion US dollars per year.

Difficulties and problems with Letters of Credit

So what can go wrong with Letters of Credit

  • It is now difficult to get technical checkers and it is questionable whether small Letters of Credit are profitable
  • It is questionable if they are 100% self-liquidating
  • There is more regulation surrounding trade finance generally
  • More risk is attached to some countries that banks are now prevented from dealing with
  • LCs are now sometimes used for payment and not seen as just a guarantee for payment

In many emerging market banks the LC is sometimes seen as a revocable instrument. This is due to poor drafting and governing law clauses added, potentially leading to legal issues. The UCP 600 doesn’t cover this:

  • The LC does not always reflect the commercial reality of today’s market;
  • Sales managers sometimes accept L/Cs from buyers without understanding the cost and risk implications to the business;
  • Difficult terms can mean delays and resultant costs through the requirement for amendments or presentation of further documents;
  • Staff may pay insufficient attention to detail when preparing documents;
  • Information needs to be efficiently shared by all people involved in the process;
  • It may be difficult to deal with a bank in which there is no prior relationship; and
  • Inexperienced document checkers may raise issues and slow the process down.
UCP 600, Letters of Credit, ICC, Trade FInance

What this means for your business when financing trade

Ultimately, when transacting large amounts, careful consideration and care should be undertaken to reduce risks for the business. It is always worth spending extra time liaising with your financiers, lawyers and accountants and ask probing questions to make sure that you’re sufficiently protected. It’s also worth considering that for Trade and Export Finance, a Letter of Credit isn’t the only form of guarantee in a transaction.

NEXT >> Restricted Letters of Credit

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About the Author

Trade Finance Global (TFG) assists companies with raising debt finance. While we can access many traditional forms of finance, we specialise in alternative finance and complex funding solutions related to international trade. We help companies to raise finance in ways that is sometimes out of reach for mainstream lenders.

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