Letters of Credit

Letters of Credit (LCs) are secure and widely recognized instruments crucial for financing trade transactions. They provide a reliable payment guarantee to both importers and exporters. 

How they work:

• Issuance: An LC is issued by a bank (the Issuing Bank) on behalf of the importer (the applicant). The Issuing Bank provides a written commitment to the exporter (the beneficiary) to pay a specified amount under certain conditions.

• Conditions: Payment is made upon presentation of specified documents that comply with the terms and conditions set out in the LC. These documents typically include invoices, shipping documents, and certificates of origin, among others.

Types of LCs:

• Documentary LC: Requires the presentation of documents evidencing the shipment of goods.

• Standby LC: Acts as a safety net, ensuring payment if the buyer fails to fulfill the payment obligation.

Benefits:

• For Exporters: Guarantees payment upon meeting the terms, mitigating the risk of non-payment.

• For Importers: Ensures that the goods or services ordered are shipped as per the agreed terms before the payment is made.

Documentary Collection

Documentary Collection is a payment method where the exporter entrusts the collection of payment to their bank, which sends documents to the importer's bank for payment. Here’s a detailed look at the process:

Process:

• The exporter ships the goods and submits the required documents to their bank.

• The exporter’s bank sends these documents to the importer’s bank along with instructions for payment or acceptance.

• The importer’s bank releases the documents to the importer upon payment (Documents Against Payment) or upon acceptance of a bill of exchange (Documents Against Acceptance).

Role of Banks:

• Exporter’s Bank: Acts as the remitting bank, forwarding documents and collection instructions.

• Importer’s Bank: Acts as the collecting bank, handling the documents and facilitating payment.

Benefits:

• For Exporters: Ensures control over the goods until payment or acceptance is received.

• For Importers: Provides assurance that payment will only be made when the documents (and thus the goods) are in order.

Guarantees

Guarantees are financial instruments used to secure obligations in international trade, ensuring performance and mitigating risks. Here’s a detailed explanation:

Issuance:

A guarantee is issued by a bank on behalf of a client (the applicant) in favor of a third party (the beneficiary). The guarantee assures the beneficiary of payment or performance in case the applicant fails to meet their obligations.

Types of Guarantees:

• Performance Guarantees: Ensure the completion of a contract according to agreed terms.

• Payment Guarantees: Assure payment to the beneficiary in case of default by the applicant.

• Bid Bonds: Provide assurance that the bidder will honor their commitment if awarded the contract.

• Advance Payment Guarantees: Secure advance payments made to the supplier or contractor.

Benefits:

• For Beneficiaries: Provides financial security against non-performance or non-payment.

• For Applicants: Enhances credibility and trust with trading partners, facilitating smoother transactions.

Process:

• The applicant requests their bank to issue a guarantee.

• The bank evaluates the applicant’s creditworthiness and issues the guarantee to the beneficiary.

• If the applicant defaults on their obligations, the beneficiary can claim under the guarantee.