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Why Letter of Credit

In the first place, why Letter of Credit (LC)? Is there any other alternatives? Why is LC still the highly utilized method to conduct international trade?


In this blog, we hope to explain as much technical detail as possible in layman terms. We hope you can easily grasp the concept and apply the knowledge to your operation. We hope to address some of the questions that you have in mind surrounding LC and hope you can benefit from it.



What is an LC?


A Letter of Credit, which from now onward we shall address it by its short form - LC, is an undertaking by a bank, called the Issuing Bank - which is a bank appointed by a buyer to a transaction to issue an LC to the benefit of Beneficiary, which is the seller, to make payment to the benefit of the Beneficiary mentioned in the LC upon fulfillment of all the terms and condition stipulated in the LC.


Such undertaking is irrevocable by default, unless stated otherwise. This means, as a seller, as long as you are confident that you can fulfill all the terms and conditions stated in the LC, you can be pretty much assured of receiving your payment when it's due. This is because the bank that issued the LC undertakes to make the payment as long as the terms and conditions stated is fulfilled.


How is this beneficial for me as a seller?


An LC gives you some degree of certainty to receive payment, because the entity who issue the LC is deemed to undertake to make the payment when it is due, as long as the terms and conditions stated in the LC is fulfilled.


As opposed to many other options of settlement, this method gives you more certainty that you will receive you payment, because the entity who issue the LC is deemed to undertake to make the payment when it is due, as long as the terms and conditions stated in the LC is fulfilled.


This certainty comes with higher cost, as opposed to other options of settlement that would require less documentation and less undertaking from the buyer's party or bank. You can select this option if you wish to have a peace of mind and do not mind producing more paperwork in exchange.


How is this beneficial for me as a buyer?


As a buyer, you might want to set a specific and highly detailed requirement on the product that you are purchasing. You might need some inspection certificate from a reputable inspection company, some certificate from accreditation organization on the product, or some other custom requirement that you need.


When you issue an LC to a seller, you can first make an agreement with the buyer on all those terms and conditions, and then include those terms into the LC terms. In the event that the seller do not fulfill any of the terms stated in the LC, you will have the discretion whether to accept the non-compliance, receive the goods and make payment.


Such kind of certainty would come with a worthy extra cost as you are involving your bank into the agreement. The bank that you appoint might also need to be comfortable with your credit-worthiness before agreeing to issue an LC as per your instruction.


Is it possible that an LC is issued by an entity other than a bank?


It is possible for an LC to be issued by an entity other than a bank. In this case, it is in your discretion as a seller whether or not to accept such issuance and arrange delivery of the goods. In this case, your comfort level should be based on the credit-worthiness of the buyer, country risk, and your relationship of the buyer.


People's perception to compliance could differ from one individual to another. How do we make sure compliance is standardized?


We get it that you might think that the seller might have felt that they have complied to all the terms stated in the LC, and yet they worry that the buyer disagrees to that fact.


This is why the examination of an LC is regulated by the International Chamber of Commerce, under the Uniform Customs Practice (UCP). The latest version of the UCP is currently the UCP600, with a supplement to its electronic version eUCP.


We hope this article helps with some of your questions around LC. If you wish to find out more, do check out our blog https://www.lcassistsg.com/blog-1


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