Importance of Letter of Credit

In international trade, since the buyer and seller are quite distance from each other, a problem often arises as to when to make the delivery of the goods and when to make the payment for the delivery. This problem is absent in trading within the national boundary as both the buyer and seller can meet each other and settle the deal. However, in international trade, neither the exporter nor the importer can rely completely upon each other. A letter of credit is an effective instrument that not only solves the problem but also acts as a means of finance for the buyer. This method is a compromise between the buyer and the seller because it affords certain advantages to both the parties. The exporter is assured of receiving payment from the issuing bank as long as it presents documents in accordance with the letter of credit. It is important to point out that the issuing bank is obligated to honor drawings under the letter of credit regardless of the buyer’s ability or willingness to pay. On the other hand, the importer does not have to pay for the goods until shipment has been made and the documents are presented in good order. However, the importer still must rely upon the exporter to ship the goods as described on the documents, since the letter of credit does not guarantee that the goods purchased will be those invoiced and shipped. So, the usual time of payment under a letter of credit is when shipment has been made, while the goods are available to the buyers after payment. The risk to the exporter is very little or none, depending on credit terms, while the risk to the importer is that he has to rely on the exporter to ship goods described in the documents. Because of all the protection and benefits it accords to both the exporter and importer, letter of credit is a critical component of many international trade transactions.

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