03 Feb Letters of credits as trade instruments in international business
Letters of credit are a payment instrument widely used in operations, especially international purchases and sales of goods.
Every transaction involves risks for the parties taking part in it, the buyer wants to make sure that he receives the goods in perfect condition and the seller always wants to ensure the collection and cover his position against defaults in any way possible.
These risks and this uncertainty for the parties is increased in cases in which the merchandise has to cross several countries until arriving at its destination, whether the transport is terrestrial or in case the shipment requires a great maritime transport operation . This increased risk occurs both for the length of the operation and perhaps for the lack of information on the ground for the parties.
In the elimination of uncertainty in international operations of all types, the International Chamber of Commerce has played a very important role since it was set up in 1919. This institution drafted the Rules and Uniform Uses of Letters of credit .
What is a Letters of credit?
It is an agreement or payment method by which a bank is to be committed at the request of the buyer who is also the importer of the goods to be paid to the seller or exporter when the seller submits the documents proving the dispatch of the goods. In summary, there is someone, who is a buyer (also called as importer or payer) who requests the opening of the credit to a bank so that it is the bank that pays at the first request, and without being able to oppose any argument as long as he submits the appropriate documents , to the seller (who is the exporter or also called the beneficiary). These documents in the field of maritime transport are known as Bill of lading (BL), document that certifies that the cargo has been received by the ship for transportation. This document accredits the fulfillment of the obligations by the seller, enabling the payment by the bank where the documentary credit was opened.This payment can be made directly by this bank, or through another bank located in the country of the seller, so in this case the parties would be four.
What is the advantage of using a letter of credit?
First, it guarantees the position of both parties, because the seller-exporter only allows the goods to leave when the bank has been forced to pay and the documentary credit has been opened and, on the other hand the buyer or importer satisfies his desire to obtain financing for the operation. It brings security and transparency to the parties. It also has the advantage that documents which certifying the issuance of goods (such as Bill of lading -BL-), usually have the status of securities (such as checks and bills of exchange) being able to be endorsed and used to transmit the ownership of the merchandise shipped to third parties, in order to finance other operations.