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Exporting and importing includes possible dangers. Exporters run the danger of buyers neglecting to pay for the goods, while buyers may arrange payment yet never receive anything.
One method for lessening the dangers is to utilize a Letter of Credit, alternatively known as a 'documentary credit'. This offers a guarantee to the shipper that they will be paid. Alternatively the buyer can be certain that no payment will be made until they receive the goods ordered.
Depending on the circumstances there are several different types of letters of credit to utilize.
A Letter Of Credit
A letter of credit is fundamentally an insurance from a bank that a specific seller will receive due payment from the buyer. The bank ensures that the seller will be paid the agreed fee within a specified time scale. In order to receive the agreed payment, the bank will demand that strict terms are met. The bank will require certain documents as proof.
The Advantages Of Using A Letter Of Credit
Letters of credit are normally utilized when a buyer from one nation buys products from a seller from a different nation. The seller may request for the buyer to arrange a letter of credit to ensure payment for the goods ordered.
Advantages For Selling
By requesting the appropriate letter of credit, the seller is assured that they will receive the funds in full and on time. A letter of credit is a secure method to receive payment for sellers providing they meet the instructed terms and conditions. The danger of non-payment transfers from the seller to the bank, or banks.
Advantages For Buying
At the point when a buyer utilizes a letter of credit they can be assured that the seller will agree to their side of the sales order and surrender documentary evidence.
It's critical that traders be mindful of the extra expenses included in utilizing a letter of credit. Banks charge for issuing them, it’s sensible to weigh up the expenses against the security advantages.
The seller needs to be mindful that they will only receive their funds if they comply to the strict terms and conditions of the letter of credit. The seller has to provide documentary evidence confirming they have supplied the exact goods as per the sales order.
However, using a letter of credit can sometimes cause administrative problems and delays.
The Right Time To Use A Letter Of Credit
In spite of the fact that letters of credit can be a valuable option, it’s often wise to avoid using one for a shipping order. They can often bring about costly delays, bureaucracy and startling expenses. When in doubt you should only consider having a letter of credit issued, as a buyer, for the following reasons:
· The seller insists on it
· National exchange controls request it
When An Exporter (Seller) Should Request For A Letter Of Credit To Be Issued
Important conditions to consider:
· Legally, does the country of destination require one
· Does the payment that the seller is due to receive justify the bank charges and extra costs involved in requesting a letter of credit to be issued, and who will be responsible for these costs
· Does the buyer have a positive and trustworthy credit and/or payment history
· What risks are associated with the country of destination, is the end destination politically stable with a positive reputation as an international trader
· Is it standard for sellers to utilize letters of credit when trading with that particular nation, and/or for that specific commodity
Different Types Of Letter Of Credit
The most five commonly used types of letter of credit are (each has distinctive features and some are more secure than others):
Other types of letter of credit are:
· Back To Back
A letter of credit may be a combination of two types, confirmed and irrevocable.
Irrevocable And Revocable Letters Of Credit
A revocable letter of credit may be amended or cancelled by the issuing bank at any time and for any given reason.
A irrevocable letter of credit cannot be amended or cancelled unless all parties agree. This provides more security than revocable letters of credit.
Confirmed And Unconfirmed Letters Of Credit
At the point when the buyer requests a letter of credit they generally do so with their own particular bank, known as the issuing bank. The seller will typically need a bank in their nation to confirm that the letter of credit is legitimate.
For additional security, the seller may request for the letter of credit to be confirmed by the bank that checks it. Upon confirmation of the letter of credit, the second bank consents to ensure payment regardless of the possibility that the issuing bank neglects to make it. A confirmed letter of credit offers more security than an unconfirmed letter of credit.
Transferable Letters Of Credit
A transferable letter of credit can be transferred from one beneficiary (the seller receiving the funds) to another.
Standby Letters Of Credit
A standby letter of credit is a guarantee from the bank that the buyer has the funds to pay the seller. The seller expects not to have the need to draw on the letter of credit to receive funds.
Revolving Letters Of Credit
A solitary revolving letter of credit can cover more than one transaction between the same seller and buyer.
Back To Back Letters Of Credit
Back to back letters of credit may be utilized when a intermediary is included yet a transferable letter of credit is not suitable.
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