Documentary letters of credit aid international trade and help big businesses to tide over cash crunches while protecting their ability to trade. Import letters of credit as documents help the importer to reduce the risk connected with the seller not meeting the delivery obligations. The imported goods will be delivered in tandem with all the conditions specified in the letter of credit, and the documents agreed upon will also be received relatively quickly and with greater ease.
On the other hand import letters of credit help exporters to reduce the risk of non-payment for delivered goods, as in case of presentation of documents which fully conform to requirements by the seller, the issuing bank pays the amount agreed upon independently of the importer.
Importers and exporters can choose from revocable and irrevocable letters of credit, both of which have distinct features depending on the level of risk involved. Revocable letters of credit are the most risky form of letters of credit and allow the issuing bank (at the applicant’s request) to change or cancel the credit at any time without the approval of the exporter (beneficiary). Whereas irrevocable letters of credit contain terms and conditions which cannot be changed without the express consent of the three parties, the issuing bank, the applicant and the beneficiary.
Letters of credit offer the following advantages to importers:
- The importer can take advantage of the possibility of structuring the payment plan in the contract in a manner which will protect his own interests.
- Ensuring that payment will be made only in the event that the documents confirming shipment of the goods are presented.
- As a trade mechanism, the letter of credit allows the importer to avoid or reduce the need for pre-payment.
- The seller is required to meet all terms and conditions of the contract, as specified in the letter of credit ( with reference to matters such as amount, shipment of the goods, meeting delivery terms on stock and deadlines) in order to receive the payment.
- With the letter of credit the importer proves his ability to pay and can look forward to being given more favorable payment terms in the future.
Conversely, letters of credit give the following advantages to exporters:
- Payment upon presentation of the documents specified in the terms of the letter of credit is guaranteed.
- Production risk is reduced in instances where the buyer either cancels or alters his order.
- Delivery can be scheduled in line with the exporter’s interests.
- The exporter has the opportunity to gain access to finance for production or purchase of goods i.e. pre-export finance.
- He also has the opportunity to get finance for the interim period between the shipment of the goods and receipt of payment more so in case of delayed payment.
- The buyer cannot refuse payment citing any complaint with regard to the goods.
- The importer is required to raise any complaints/claims about the goods delivered independently of the letter of credit. This facility gives the exporter a significant advantage in resolving such issues.