What is a letter of credit and how can an exporter use it when exporting?

 

          A letter of credit (L/C) is an arrangement whereby a bank (the issuing or opening bank) guarantees on behalf of its customers (the applicant or importer) to make payment to the beneficiary (or exporter) upon presentation of documents specified in the credit, under specified terms and conditions.  The financial transaction may be further secured by the intervention of another bank.  The intervening bank informs the exporter of the issue of the L/C and may add its confirmation to it, thereby guaranteeing the payment against the risk of default of the issuing bank.

 

The L/C is a very precise document, usually created by following an international standard form model.  It contains a brief description of the goods, a listing of documents required to obtain payment, the shipping date, and the expiration date after which the payment will no longer be made.  The L/C guarantees the exporter will be paid only after fulfilling certain terms and conditions.  Upon the fulfillment of all the conditions set down in the L/C, the exporter can submit appropriate shipping documents to the bank to collect payment.  The following documents are required to be submitted in order to obtain payment according to the L/C (however, there are no specific rules on what an L/C most often should require):

 

·            Commercial invoice

·            Bill of lading (B/L) or another multi-modal transport document proving that the goods have been embarked for transport, sometimes also evidencing that the freight has been pre-paid

·            Insurance document

·            Certificate of origin

·            Inspection certificate showing conformity to quality, quantity, packaging requirements

·             Packing list

 

If the exporter has a long-standing relationship with the foreign buyer, cash advance may be the easiest form of payment.  If this is not the case, the letter of credit can act as the easiest way of getting paid while, at the same time, protecting the exporters interests.  The most commonly used forms of L/C are:

 

Irrevocable Documentary L/C  This form of L/C cannot be canceled or modified without agreement of all parties involved.  Payment is guaranteed by the bank provided that the exporter fulfills all the terms and conditions laid down in the contract, including the presentation of the required documents.

 

Revocable L/C.  This form offers fewer guarantees but is more flexible as it can be canceled or modified at any time without the knowledge of beneficiary.  A few exporters accept these L/Cs.

  

Revolving L/C.  This form is often used in repeated trade transactions with the same client.  The funds used for the same or a similar transaction will again be available in the future, usually under the same terms without having to issue a new L/C.

 

Although a letter of credit is used most frequently in the process of payment, there could be several problems in employing this method. 
reference: 

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The Export Answer Book
for Small and Medium-Sized Exporters
 in the Sultanate of Oman