Commercial letters of credit (CLCs) are the most actively used structured payment instruments in international trade. They have been available for decades — long enough for exporters to have figured out how to effectively use them. If only this were true. In reality, large numbers of exporters are not aware of the pitfalls.

The single goal of a CLC is to provide a secure, efficient and prompt payment instrument so the exporter feels comfortable selling goods to a buyer who is unwilling or unable to pay before the goods are shipped. But in order to get paid promptly, the exporter needs to understand that the documents must strictly comply with the CLC requirements. This is more difficult than it sounds.

If the exporter presents “complying documents” he or she should get paid fairly quickly, usually within 7 to 14 days after the documents have been presented to the advising bank. In cases where an exporter is able to prepare and submit electronically produced documents, payment might be in 2 to 3 days.

Do most exporters get paid quickly? The unfortunate reality is no!

Do most exporters get paid quickly? The unfortunate reality is no! And statistics don’t lie.

Between 75 to 85 percent of all documents presented to advising banks around the world under CLCs for payment are deemed to be incorrect or termed discrepant. This means the advising bank will not pay the exporter until the documents are corrected and re-submitted, or the buyer agrees to accept the discrepant documents. The result: there will be prolonged delay in payment.

This situation creates frustration and aggravation to the exporter who erroneously believed or was told that the CLC was supposed to guarantee a secure and prompt payment. When a discrepancy situation occurs, the umbrella of protection initially provided by the CLC to the exporter is suspended until or unless the discrepancy situation is corrected. This often becomes a mess!

In The Spotlight

Exporters are at a disadvantage in the international trade arena. Why? Most of the literature, including textbooks, how-to-books, white papers and e-books, do not teach exporters what they really need to know. And there are few people who accurately understand the process and mechanics of CLCs, and teach it.

Importers, on the other hand, have a distinct advantage in using CLCs. This is because the importer’s bank, known as the issuing bank, has a self interest in protecting its customer, the buyer. In addition, the issuing bank is taking the ultimate credit risk in the CLC.

Can exporters expect the same help from the advising bank? Many assume the answer is yes. Unfortunately, this is not the case. Advising banks do not take any credit or payment risk in a typical CLC, so they generally won’t spend the time providing advice to the exporter.

In fact, because the exporter is using a CLC for payment purposes, advising banks often assume he or she understands the process and doesn’t need help. What’s more, since the advising bank usually makes very little money through minimal fees on a typical CLC, it is not very motivated to provide assistance.

The problem can be corrected through better education. But as noted above, most books and subject-specific literature isn’t very helpful.

And while institutes on the internet often claim to offer the “best education” on letters of credit, they don’t. Additionally, many banks offer training seminars, but often fall short by only explaining what letters of credit are, and how they are used in global business. This same approach is often replicated at colleges and universities.

Why don’t these entities offer more useful education and training?

The instructors, many of whom are retired bankers, often do not have an in-depth knowledge of how CLC mechanics really work. And others may understand the function and processes involved, but are not able to explain the mechanics of setting up a CLC. As a result of these realities, exporters are wise to very carefully select where and how to become better educated and truly understand how to use CLCs effectively.

Share

Chip Thomas
About The Author Chip Thomas [Full Bio]
Chip Thomas is founder of the American Export Training Institute (AETI) and author of Trade Finance Handbook available at Amazon.com. He has been educating exporters on commercial letters of credit best practices for over two decades.




Trade Finance Handbook


You don't have permission to view or post comments.

Quick Search

Stock Watch

FREE Impact Analysis

Get an inside perspective and stay on top of the most important issues in today's Global Economic Arena. Subscribe to The Manzella Report's FREE Impact Analysis Newsletter today!