The import/export trade is a global business that sees buyers and sellers interacting across international borders and diverse jurisdictions. Often, the two parties may not even know each other, or even trust one another completely. This is where a Commercial Letter of Credit (LC) shines as it provides a regulated, enforceable and guaranteed mechanism to ensure payment for delivered goods.
What It Does
An LC, through the use of a bank as trusted a 3rd party intermediary, not only guarantees payment for goods supplied, but also works to ensure that the seller cannot directly obtain the payment without fulfilling the requirements of the buyer.
Thus, an LC is probably the only trade finance instrument that equally minimizes risk for both parties to an international trade transaction. The seller must deliver the goods in full to claim the payment, and the buyer must pay to the seller the full amount agreed upon (the issuing bank guarantees this) no sooner the goods are supplied in full. Usually, this requirement is met upon successful consignment of the goods and presentment of the shipping documents, such as the Bill of Lading, to the bank.
Importance for SMEs
Guarantee of Payment – For small export businesses, a single delayed or lost payment can be irreversibly damaging. Therefore, using an LC means that this risk is completely avoided. The converse is true for small import businesses as well; a single failure of a seller to deliver on a large shipment can be devastating.
Access to Credit/Improved Cash Flow – An LC is typically a negotiable instrument, thus allowing the exporter to use it as collateral against which to borrow funds for short term needs to fulfil the shipment. This allows for much improved cash flows for the exporter and prevents them from obtaining long term debt to fulfil working capital requirements, thus aiding them to maintain a healthier financial position. For importers too, based on their arrangements with their bank, there is significant room for freedom of movement with regard to cash flow and working capital needs, when using an LC.
Choosing the Right Partner
When you decide to enter into an international trade transaction governed by an LC, it is necessary to choose the right partner. An international bank, located in a financial centre, with an experienced team, is the best choice. In this digital age, you should also look for a bank that has embraced the latest digital technology such as blockchain, enabling smart contracts, electronic LCs and cutting-edge international settlement mechanisms.
At Euro Exim Bank, we are proud to be a leader in the sphere of trade finance, providing relevant solutions for today’s times using best-in-class digital technology. Based in London, we are ideally positioned to be your trade finance partner in an ever-changing world and burgeoning global marketplace.
