LC is a letter of credit payment mechanism used in international trade. An exporter can make a secure transaction with LC ( letter of credit) issued by a confirming bank.
The exporter is guaranteed payment with a confirmed letter of credit,(LC) even if the issuing bank of the importer defaults in paying, the Confirming Bank of the exporter will complete the payment in full to the exporter.
LCs play a crucial role in international trade by protecting both buyers and sellers. Letter of credit is also known as documentary credit
Features of an LC
- Guarantee: A bank issues an LC to guarantee that a importer will pay a exporter on time and in full.
- Responsibility: The bank assumes the responsibility of ensuring the exporter is paid.
- Collateral: Buyers/importers must prove they have sufficient assets or a credit line to cover the payment.
- Types: Types of LCs, include commercial, revolving, confirmed, and standby letters of credit.
- Fees: Banks charge a fee for issuing an LC, which varies based on the credit amount and type.
A confirmed letter of credit (LC) involves two banks:
- Issuing Bank: The buyer’s bank issues the LC.
- Confirming Bank: The seller’s bank adds its guarantee to the LC.
How LC works:
- Buyer(importer) and seller (exporter)agree on terms of letter of credit.
- Buyer’s bank issues the LC.
- Seller’s bank confirms it.
- Seller ships goods.
- Seller presents shipping documents to confirming bank.
- Confirming bank pays seller.
The confirmation ensures payment even if the buyer’s bank defaults
How long does it take to process an LC?
The processing time for a letter of credit (LC) can vary based on factors such as complexity, banks involved, and documentation. Generally, it takes a few days to a few weeks. The steps include agreement, LC issuance, document submission, and payment. If you need more specific details, consult your bank or trade finance expert.
What are the risks of using an LC?
Using a letter of credit (LC) involves some risks:
- Cost: LCs come with fees, including issuance and amendment charges.
- Document Compliance: Sellers must provide accurate documents to get paid.
- Payment Delays: If documents are incorrect, payment may be delayed.
- Bank Risk: Buyer’s bank could default, affecting payment.
What are the advantages of using an LC in international trade?
- Risk Mitigation: LCs provide security for both buyer and seller. The buyer knows the goods will be shipped before payment, and the seller is assured of payment if documents comply.
- Global Acceptance: LCs are widely accepted in international transactions, making them a trusted payment method.
- Trade Facilitation: LCs streamline trade processes by standardizing payment terms and documentation.
- Currency Flexibility: LCs can be denominated in various currencies, allowing flexibility.
- Credit Enhancement: Seller’s bank confirmation enhances creditworthiness.
Bottom line: An exporter should always trade with a ‘confirmed LC’ issued by the confirming bank of the exporter.