Chapter 3 Understanding trade
The importer controls the opening
and issuance of the letter of credit. This
means the importer has the responsibility
for arranging the appropriate terms and
conditions, which should be agreed when the
two parties initially contract. In many cases
the exporter will send the importer a set of
terms and conditions to include in the letter
of credit to minimise the risk of confusion or
dispute later and ensure goods are able to be
cleared through customs efficiently.
The customer, the importer, often has the
ability to dictate the timing of the payments.
Broadly speaking, there are four alternatives
under the terms of a letter of credit:
Sight. This means payment is made at the
point the title documents are presented
to the importer (applicant). This can be
done without a bill of exchange, but a
sight bill is usually used. (Note that under
a sight transaction, where a full set of bills
of lading is required, the bank will have
effective title, as the bills would normally
be to order and blank endorsed. If the bank
has control in this way, it may be more
comfortable with the underlying credit and
provide a more competitive rate.)
Deferred payment. This means
payment is made a set period of time
after presentation of the title and other
documents to the importer. A bill of
exchange is sometimes used.
Acceptance. For payment to be made, the
terms of the letter of credit must be met
and the accepting bank will accept a bill of
exchange at that point. Payment will then
be made according to the terms in the letter
of credit – which could be on a specifieddate or a set period after presentation of
the letter of credit or acceptance of the bill.
(This can normally be discounted at the
request of the beneficiary.)
Negotiation. If a negotiable letter of credit
is issued, the issuing bank pays the bank
which negotiates the bill of exchange.
Finally, the importer can often choose the
currency of payment, although this will depend
on the relationship between the two parties.Risks and advantages for sellers/exporters
Exporters face a reduced risk by using
a documentary credit compared with
documentary collections, because they
effectively have a guarantee of payment
from a bank. This does rely on the exporter
complying with the terms of letter of credit, so
care needs to be taken in the preparation of
the documentation. As with a documentary
collection, it is important that the exporter has
sufficient resource to be able to prepare and
present documents in accordance with the
terms of the letter of credit.
However, there is still a risk that the bank
may not honour the terms of the letter of
credit. There is also a country risk, in the
sense that payment under the letter of credit
may be affected by any debt rescheduling for
that particular country.
Local customs rules also apply, and the
exporter will need to ensure that the shipment
does not breach the terms of any local import
rules or restrictions and, if necessary, an
appropriate import licence is obtained.
Because of the central role of banks in
the process, the treasurer will also want
to assess the creditworthiness of theUnderstanding the business cycle is
critical to this transaction. The importer
approached its bank when looking to
tender for the blue chip contract. It
understood it ran a significant risk to its
reputation if it had won the tender and
then found it could not finance the deal.The bank was prepared to support the
importer because it had supported the
company on smaller, sample deals, and
had helped the importer build up a track
record of steady working relationships
with its suppliers in Asia.