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
- 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. 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.
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 – some our funders can secure a transaction on existing inventory and stock, or future invoices. Learn more about letters of credit.
Find out more about the details on Supply Chain finance here.