A Letter Of Credit (LC) is an irrevocable undertaking from the Bank issuing it to pay the Beneficiary (normally a supplier/exporter) against a presentation by them of specified documents. An LC is issued on behalf of the buyer/importer – called the Applicant. In simple terms it is a performance guarantee. The seller/supplier knows as long as they perform in line with the terms of the LC they will be paid, while the buyer knows they will only release the payment when the terms of the LC have been complied with.
To say the Letter of Credit is as old as the hills, is an understatement. Some scholars believe it goes back as far as the Egyptians and Babylonians, 3000 years ago. The underlying principal has remained the same, a process to give both sides confidence of performance against payment. This is even more so if the parties are unknown to each other. In recent times cheap capital and globalisation has meant payments increasingly have been made on open account.
How secure is open account in a default scenario? Not very is the answer. If a large deposit is paid or a transfer on Telegraphic Transfer (TT) is made your business is relying heavily on the goodwill of the supplier, often in a far-flung part of the world. If the supplier collapses you have very little recourse as you will be relying on local regulation/the insurance market. An LC can give both parties confidence on performance, the supplier can often draw working capital against the LC from its bank and the buyer knows the supplier must perform not only the contract but within the allotted time. The benefit is that it is an upfront payment so the buyer can often avail of a discount. Also, if your supplier does collapse, the funds are not released from the LC as the contract hasn’t been performed.
Is an LC cumbersome? Not really, it requires a level of detail as an exporter/importer should know or require anyway. Do discrepancies arise? Yes, but they are normally minor so just require an acceptance by both parties.
We at Growcap Finance take care of this process, we can also help you manage your trade flow as the LC is issued in our name therefore we deal with the paperwork. Our process can give you peace of mind as well as freeing up employee and management time by managing the trade process for you. Why not contact us at www.growcapfinance.com.