Letters Of Credit

If you regularly import or export goods, a good way of freeing up funds is a letter of credit or documentary letter of credit. These are open lines of credit agreed up to a specific amount by both parties. They guarantee that the exporter will be paid by the importer within a specified timeframe on satisfactory presentation of documentation agreed in the terms of the letter of credit. The transaction, itself, is usually the primary security although sometimes, additional security may be required.

We routinely arrange "Letters of Credit" for exporters based in many parts of the world so if you would like to know more please contact us.

Why letters of credit can benefit your business

If you regularly import or export goods and services letters of credit will help you facilitate the process. There are two main reasons for this.

1. Letters of credit are the most widely used type of trade finance in the world so they are familiar ground to most import-export operators.
2. They provide security to both parties; both importer and exporter i.e. buyer and seller. Both parties must follow the agreed credit terms for a set fee.

Once you have agreed the terms to a letter of credit, the fee increases if the schedule is varied. The issuer of the letter of credit will not inspect goods so you will need to make sure they are inspected before shipment to avoid any delays to the schedule.

How letters of credit work - the process

Outlined below is a typical scenario in which you might find a letter of credit being used. In this instance a wholesaler based in the UK is buying from a manufacturer overseas. Here is and example of how the process might work:-

• The wholesaler issues a purchase order to their overseas supplier and a letter of credit is opened to the supplier for 100% of the goods. Terms are agreed by both the wholesaler and supplier as to how much will be paid, when and in what form.
• The supplier ships the goods to the wholesaler and submits the relevant documents to the lender.
• The goods arrive at port and the await release for customs clearance. This release is given by the lender.
• The wholesaler submits a request to the lender for funds to make full payment for the goods and the lender pays the wholesaler.
• The lender releases the goods to the wholesaler. He then uses the money the lender has paid him to pay the supplier in the manner agreed when they negotiated the letter of credit.
• The buyer ships the goods on to their customer then pays the lender.

What lenders will need to know to issue a letter of credit.

Here are three things your lender will need to see if you are applying for a letter of credit.

1. A brief outline description of the transaction.
2. A pro forma invoice for the goods to be supplied.
3. Proof that the transaction is taking place, for example, a copy of the contract, a memorandum of understanding or similar.

Different types of letter of credit

There is more than one type of letter of credit, in fact there are eight which are listed below:-

1. Irrevocable - the default option. These are only binding if all terms and conditions are met and once negotiated, they cannot be amended or cancelled without the agreement of everyone involved.
2. Revocable - these offer little security so are not often used. The importer can cancel at any time until the documents are taken up by the bank.
3. Confirmed - this type of letter of credit confirms that payment will be made by the advising bank (usually an international bank) if the issuing bank or the buyer fail to pay, this facility comes at higher cost and is not available under certain circumstances.
4. Unconfirmed - these letters of credit are authenticated by the advising bank and forwarded to the exporter but offer no guarantee of payment.
5. Revolving - a type of letter of credit used for repeat transactions, for example when the same company is importing the same product from the same supplier. The letters revolve over time or value and can do so automatically or subject to agreed terms and conditions.
6. Standby - a standby letter of credit is essentially a back up option for a transaction where a less secure payment option has been agreed. It is negotiated before the transaction but not used unless the importer fails to pay. Then it can come into effect, allowing the supplier to claim payment, so long as both parties have adhered to its terms and conditions.
7. Transferable - these letters of credit are used to transfer part or all of the credit value to one or more third parties, in particular where transactions are facilitated via brokers and there is a need to finance the purchase from the ultimate supplier.
8. Back to Back - this is a higher risk alternative to a transferable letter of credit and would be used to open second letters of credit. They are not usually made available because of the higher risk the issuing bank would be exposed to.