An irrevocable letter of credit is a financial
instrument issued by a bank at the request of a buyer to ensure payment to a
seller. Under this arrangement, the seller ships the goods to the buyer, and
the bank guarantees payment upon receipt of the necessary documentation, which
typically includes a bill of lading or commercial invoice. The bank plays a
critical role as an intermediary between the buyer and seller, effectively
mitigating the risk of non-payment for the seller and non-delivery for the
buyer.
The main properties of an LC are:
1. Security:
The letter of credit provides security for both the buyer and the seller. It
assures the seller that payment will be made if they fulfill the terms of the
agreement, and it assures the buyer that
payment will not be made until the seller has fulfilled those terms.
2.
Flexibility: An LC can
be tailored to meet the specific needs of the parties involved in the
transaction. It can be issued in a variety of forms, such as confirmed or
unconfirmed, revocable or irrevocable, and transferable or non-transferable.
3.
Document-based: The
letter of credit is a document-based transaction, meaning that payment is made
based on the presentation of specific documents, such as a bill of lading or
commercial invoice.
4.
Universality: LCs are
widely accepted in international trade, making them a preferred payment method
for buyers and sellers across the globe.
5.
Intermediary
involvement: Banks play a critical role in LC transactions, acting as
intermediaries between the buyer and seller to ensure that payment is made and
the terms of the agreement are met.
6.
Cost: The use of an LC
involves fees and charges, including application fees, amendment fees, and
confirmation fees, which can add to the overall cost of the transaction.
As any other trade finance instrument, LC has its
own merits and limitations. Most of them are as follows:
Merits:
Secure payment: LC provides a secure way to ensure
payment for goods or services in international trade, reducing the risk of
non-payment for the seller.
Risk reduction: The involvement of a bank as an
intermediary reduces the risk of non-delivery for the buyer, which is
especially helpful when dealing with unfamiliar or overseas trading partners.
Flexibility: Letters of credit can be customized
to fit the specific needs of a transaction, providing flexibility for both
parties.
Wide acceptance: Letters of credit are widely
accepted by most banks and businesses around the world.
Limitations:
Costly: There are fees associated with
issuing and processing letters of credit, which can be a significant expense
for both the buyer and the seller.
Time-consuming: The process of obtaining an LOC can
be time-consuming and complex, which can delay the transaction.
Possible disputes: Disputes can arise
between the buyer, seller, and bank over the terms and conditions of the LOC,
which can lead to delays and added costs.
Strict compliance: The terms and
conditions of an LOC must be strictly followed to ensure payment, which can be
challenging for the parties involved.
Letter of credit can be a valuable tool for
facilitating international trade and providing peace of mind for both parties
involved. However, it's important to carefully consider the costs and
requirements before deciding to use it.
No comments:
Post a Comment