The importance of letters of credit in international trading

The Importance of Letters Of Credit in International Trading Trading is widespread at both local and international levels and import finance hugely helps these trading transactions. In an import business, a buyer will require the bank or financial institution to guarantee the payment to the seller so that the seller will dispatch the shipment of goods in time and in full. The banks offer these services via trade finance tools like letters of credit, bank guarantees or collection and discounting of bills. When a bank is involved in the trade, the transaction will be smooth and obstacle free as both parties will trust the bank to complete the transaction.

Letters of credit are issued by the guarantor bank to the seller after a contract between the buyer and seller is concluded and on behalf of the buyer. For the exchange of the bill of loading the seller will consign the goods to a carrier. The seller then will proceed to the bank and provide the bill of loading in exchanging for payment. The bill is then provided by the seller’s bank to the buyer’s bank who in turn will provide it to the buyer. The buyer equipped with the bill of loading will approach the carrier in order to take delivery of the ordered goods.

Letters of credit are important bank documents that guarantee payment to the seller who will receive payment in full as long as they fulfill the conditions implied in the agreement. In the case that the buyer or importer is not able to pay the consignment then the bank on behalf of the buyer will pay the outstanding amount to the seller in full. This is hugely useful in transactions involving two parties from different countries as they won’t know each other and the matter of trust is essentially required here.

There are several risks that the seller faces during the transaction which includes credit risk, legal risks posed by long transportation, and laws applied in different environments.

Since the buyer and seller would know each other personally, the matter of trust is out of the question, and the trade will require an intermediary who would guarantee payment to the seller and shipment to the buyer. The trade financing arm of letters of credit ensures that both parties are satisfied with the transaction as every risk is taken care of the bank. A letter of credit is a great business instrument when dealing in import/export trade, especially international level trades.