Advantages and disadvantages of Letter of Credit?

Answer 1

Letter of Credit Advantages for both Importers and Exporters

For the Exporter/Seller:

• Upon presentation of the specified documents (in strict conformance) the Buyer/Exporter is guaranteed payment (the exception is if the Issuing Bank folds)
• Eliminates risk of the buyer canceling the order and therefore reduces production risk
• Makes it easier for the Buyer/Exporter to secure order/production financing-pre-export financing
• Easier to secure receivable financing (in case where the L/C is not payable At Sight)
• Buyer cannot refuse payment by raising a complaint about the goods. Any complaints must be settled between the Buyer and Seller outside of the L/C.

For The Importer/Buyer

• In most cases the Importer/Buyer avoids partial pre-payments or deposits
• Helps reduce the risk of non-performance of the Exporter/Seller. If the Exporter/Seller doesn't ship the goods they don't get paid.
• Certainty that payment will only be make to the Exporter/Seller upon presentation of documents in strict compliance with the L/C evidencing the shipment of goods.
• Documents are received quickly, expediting customs clearance and ultimate delivery
• Makes structuring an advantageous payment schedule easy
• Importer/Buyer will receive timely delivery or the goods because the L/C terms dictate latest acceptable shipment date.

Disadvantages for Using Letters of Credit (L/C's)

Now that you all think that Letters of Credit are the best way to go, think again. LC's have disadvantages to both importers and exporter. So before, deciding to use an L/C for your transaction it is worth considering the following:

Disadvantages for the Importer/Buyer:

• Ties up the business credit line
• Unless currency-hedging strategies are utilized, the actual cost of the goods can increase do to vulnerability to currency fluctuations.
• Costs involved with issuing, negotiating, and other fees (like amendments), can make L/C expensive.
• Seller's bank controls the shipping documents
• The goods shipped may not conform (inferior quality for example) to the order (remember L/C's are strictly about documents and are separate from the actual goods). Unless the seller "makes good" the only recourse is through legal proceedings.

Disadvantages to the Exporter/Seller:

• Strict compliance is required for payment. Unless all the documents are 100% compliant with the terms and conditions of the L/C the bank will not issue payment.
• Still subject to political risk of the country the L/C originates
• Subject to the financial strength and stability of the Issuing bank
• More cumbersome - requires a high level of expertise to successfully navigate the process
• More expensive than other methods of payment
• Receiving, negotiating, and other fees associated with L/C can be expensive.The paperwork can be very time consuming and cumbersome to produce