By M A Siddque. CEO at RMG Fashion Trade, Bangladesh.

Administrator & Editor, Garment earner. !!!.garmentlearner."logs#ot.$om

What is Letter of Credit?
A letter o% $redit is sim#ly a guarantee do$ument %rom a "an& or 'nan$ial
institution, ensuring that a seller !ill re$ei(e a #ayment due %rom a "uyer
on time and %or the $orre$t amount. But the seller !ill not "e #aid until the
"an& re$ei(es a $on'rmation that the goods ha(e "een shi##ed %or "uyer.
So a letter o% $redit is
"asi$ally a guarantee %rom a "an&
"an&)s !ritten #romise
!ritten $ommitment to #ay
Why use a letter of credit?
etters o% $redit are most $ommon in international transa$tions. *m#orting
and e+#orting %rom one $ountry to another in(ol(es ris&s. E+#orters %a$e
ris& o% "uyers %ailing to #ay %or goods and im#orters ris& #aying "ut ne(er
re$ei(ing anything, though "oth #arties ha(e an agreement or an
underlying $ontra$t. There are other %a$tors in(ol(e in international
dealing su$h as distan$e, di,erent la!s, di-$ulty in &no!ing ea$h other
#ersonally. *n this $om#le+ situation the use o% etters o% $redit is (ery
im#ortant in international trade. Both #arties need guarantee %or re$ei(ing
goods and #ayment. So etters o% Credit !or& as a tool to redu$e ris& %or
"uyers and sellers.
etter o% Credit./o$umentary Credit
Advantages for buyers:
Seller !ill not "e #aid until the "an& re$ei(es a $on'rmation that the
goods ha(e "een shi##ed %or "uyer.
The "an& !ill #ay the seller %or the goods only !hen all the terms &
$onditions !ill %ul'l a$$ording to the etter o% Credit. This assuran$e
#ro(ides se$urity to "uyer %or %uture "usiness #lan.
etter o% Credit redu$es ris& o% #oor #er%orman$e "y the seller.
The "uyer $an $ontrol the time #eriod %or shi##ing o% the goods.
By a letter o% $redit, the "uyer demonstrates his sol(en$y.
*n the $ase o% issuing a letter o% $redit #ro(iding %or delayed
#ayment, the seller grants a $redit to the "uyer.
0ro(iding a letter o% $redit allo!s the "uyer to a(oid or redu$e #re1
#ayment.
Shi#ment under etter o% $redit is treated !ith most $are to meet
deli(ery s$hedule and other required #arameters "y the e+#orter.
The letter o% Credit $reates $onsidera"le #ressure on the seller to
su##ly the goods !ithin the s$heduled time and !ith the required
quality
Advantages for sellers:
By the etter o% Credit the seller is reassured %or re$ei(ing #ayment
in %ull and on time.
The ris& o% non1#ayment is trans%erred %rom the seller to the "an&.
The seller $an use etter o% Credit as a guaranty %or his o!n
su##liers.
Based on a high quality e+#ort letter o% $redit, seller $an o"tain a
loan %rom "an&.
When to use a letter of credit
O% $ourse etter o% Credit is (ery use%ul, "ut it2s o%ten "est to a(oid using
one %or a transa$tion. They $an sometimes result in e+#ensi(e delays,
"ureau$ra$y and une+#e$ted $osts.
Letter of Credit from Importer:
3ou should #ro"a"ly only $onsider o#ening a letter o% $redit as an
im#orter4
*% your su##lier insists.
*% national e+$hange $ontrols require.
Letter of Credit for Exporter:
Ma&e sure you ha(e a $lear #oli$y in your "usiness a"out !hen to $onsider
using a etter o% Credit. Thin& $are%ully a"out !hether or not you need to
as& an o(erseas $ustomer %or a letter o% $redit.
*m#ortant things to $onsider4
egal matters 1 does the $ountry you2re e+#orting to require one5
Costs 1 does the (alue o% the order 6usti%y the "an& $harges and
e+tra $osts in(ol(ed, and !ho #ays these $osts5
The $ustomer2s $redit!orthiness 1 do they ha(e a tra$& re$ord !ith
you5
Ris&s asso$iated !ith the $ountry you2re e+#orting to 1 is it #oliti$ally
sta"le !ith a good re#utation as an international trading #artner5
7ormal trading #ra$ti$es 1 is it standard #ra$ti$e %or e+#orters to use
letters o% $redit !hen trading !ith that $ountry, and.or in that
#arti$ular $ommodity5
A(aila"le ad(i$e and guidan$e 1 "an&s may re$ommend using o% a
letter o% $redit in $ertain trading situations regardless o% other
%a$tors, !hile $redit insurers sometimes insist on it.
*% you do de$ide that a letter o% $redit is the "est o#tion you2ll need to
$onsider !hi$h ty#e o% letter to use. A 8$on'rmed and irre(o$a"le2 letter o%
$redit is the most se$ure ty#e.
Other important things to consider:
Ban& ma&e $harges %or #ro(iding etter o% Credit, so "e a!are o% the
additional $osts in(ol(e in using a etter o% Credit, it2s sensi"le to !eigh
u# $osts against the se$urity "ene'ts.
*% you2re an e+#orter you should "e a!are that you2ll only re$ei(e #ayment
i% you &ee# to the stri$t terms o% the letter o% $redit. 9sing a letter o% $redit
$an sometimes $ause delays and other administrati(e #ro"lems.
itfalls of Letters of Credit
etters o% $redit ma&e it #ossi"le to do "usiness !orld!ide. They are
im#ortant and hel#%ul tools, "ut you should "e $are%ul !hen using letters
o% $redit.
As an e+#orter, ma&e sure you4
Care%ully re(ie! all requirements %or the letter o% $redit "e%ore
mo(ing %or!ard !ith a deal.
9nderstand all the do$uments required.
Are truly a"le to get all the do$uments required %or the letter o%
$redit.
9nderstand the time limits asso$iated !ith the letter o% $redit, and
!hether they are reasona"le.
:no! ho! qui$&ly your ser(i$e #ro(iders ;shi##ers, et$< !ill #rodu$e
do$uments %or you.
Can get the do$uments to the "an& on time.
Ma&e all do$uments required "y the letter o% $redit mat$h the letter
o% $redit a##li$ation e+a$tly ;e(en ty#ogra#hi$al errors or $ommon
su"stitutions $an $ause #ro"lems<.
!o" to get a Letter of Credit
3ou need to $onta$t your "an& to get a letter o% $redit. 3ou !ill most li&ely
need to !or& !ith an international trade de#artment or $ommer$ial
di(ision. 7ot e(ery 'nan$ial institution !or&s !ith letter o% $redit, "ut
small "an&s and $redit unions o%ten re%er you to some"ody !ho is a"le to
a$$ommodate your needs.