Exporting goods across borders is complex and exposes a wide range of risks of non-payment from the buyers.
Here, "Trade finance" ensures fast, efficient, reliable, and comprehensive solutions in foreign trade activities and Letter of Credit (LC) is the oldest and safest mode of payment in trade finance.
When there is no or little information about the creditworthiness of the buyer, it is safer to ship goods on an Irrevocable Letter of Credit. A letter of credit (LC) is a document that guarantees an exporter for its buyer's payment through LC issuing Bank/institution. Irrevocability ensures that the contract (LC) cannot be cancelled without the consent of all parties. In this way, the exporter is not taking the payment risk on the buyer, but on its LC issuing bank. As a benefit to the importer, LC ensures that goods will be delivered as per terms defined in LC and the payment to the buyer will be made only on complied presentation (documents presented in the bank should be as LC terms). Hence, LC gives a platform to exporters and Importers for safe and reliable trade.
If the exporter presents the complied documents (proof of shipping the correct goods, such as bills of lading) to advising/negotiating/ confirming bank– they are likely to get guaranteed payment.
Confirming Bank here plays a very big role in realizing the money. Confirming bank as a party of letter of credit confirms and guarantees the exporter to undertake the responsibility of acceptance /payment upon complied presentation. It adds its confirmation to the LC upon the issuing bank's request. LC confirming bank undertakes the obligation of payment under the LC in case issuing bank fails to make the payment to the beneficiary of the LC (documents must have complied)
Still, there are numerous difficulties in dealing in LC such as bankruptcy of the LC issuing bank, political or country-specific risk, the authenticity of LC, etc. Other than that sometimes sales managers accept LCs without understanding the terms, complexities and genuineness of the LC.
I have witnessed various companies juggling in to minimize the risks exposed in the export business on LC terms. They face many troubles in getting the collection from some of the overseas buyers having payment terms of LC. Their money is still under-recovery. Many of the companies are avoiding Export LC due to the non-surety of the collection.
That's why understanding the benefits and risks and how we can minimize the risk is very important before any goods are shipped on the payment term of the letter of credit. The examination and understanding of the LC authenticity are very crucial to ensure payment of the exported goods. I have mentioned some of the checkpoints which may help in examining LC authenticity.
Checklist to examine Authenticity of the LC
• The Letter of Credit should be as per UCP 600 or UCP URR Latest Version.
• Identify clearly which entity has issued this letter of credit - whether the issuing entity is a bank or a non-banking entity? This will be stated in Field No.52A. (Issuing bank)
• Check the financial status of the issuing entity (LC issuing bank/entity) with your bank before processing the export order.
• In some of the transactions, the buyer is in a different country and this LC issuing entity is in another country. For example, your buyer (applicant in the letter of credit) may be in the UAE. This issuing entity may be in Gambia or Ukraine. Check the commercial and financial status of the buyer (importer).
• Check for reasons why any of the banks in the buyers' (importer's) country, could not undertake its payment obligation.
• At times, the first advising bank which has transmitted the letter of credit might have added its confirmation. This can be checked by reading Field No.40A. (Irrevocable, adding our confirmation). In this case, Field No.49 may state ‘without'. It means that the first advising bank had already confirmed the letter of credit and the second advising bank in India may advise the letter of credit ‘without' confirmation.
• First advising bank, which incidentally the confirming bank, should be financially sound. We suggest you seek the assistance of your Bank for this purpose if you do not possess the ability to verify the financial soundness of the first advising bank.
• Accept confirmed LC where the creditworthiness of issuing bank is in question. Also, accept LC confirmed from "A" rated bank preferably in your country.
Examine other terms for Complied presentation
• Company name and address should be correctly spelled.
• Currency and LC amount and Incoterms should be as per contracted amount.
• Tenure of the LC - It should be LC at Sight or if agreed for extended payment term it can be Ussance 45/60 days.
• Description of goods should be correctly mentioned
• LDS & Expiry Date should be mentioned as practically able to meet.
• Banking Fees should be charged to the correct parties.
• Please read Field No.46A (documents required) and 47A (Additional conditions). A list of required documents and details of dispatching of documents may be stated. The given terms should be vetted along with other terms of the LC and conditions that cannot be matched or complied with should be removed from LC.
• Ask for draft LC from the Buyer before transmission of final LC. In case, any amendment is required, ask the buyer to get it revised.
• Read all the terms and conditions of the letter of credit before processing the order and present complied documents as the payment can be rejected by the buyer if the bank raises any discrepancy.
The list is suggestive and exhaustive. Successful completion of your transaction depends on your alertness in checking the financial background of the buyer and the LC issuing entity's financial status. If post-examining the LC, you determine that everything is genuine and as per contracted term, that can be complied, you can proceed with the shipment or if some clauses are required to amend, it can be asked for an amendment.
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