Letters of Credit
| Pages | 21-22 |
| Date | 01 July 1985 |
| Published date | 01 July 1985 |
| DOI | https://doi.org/10.1108/eb057409 |
| Author | K.A. Dewdney |
| Subject Matter | Economics,Information & knowledge management,Management science & operations |
Letters of Credit
by K.A. Dewdney
The Letter of Credit or, more correctly, Banker's Documen-
tary Credit is widely used in international trade transactions
as an instrument to ensure that, on the one hand, the seller
receives payment for the goods he has exported, and on
the other, that the seller exports to the buyer the goods he
has ordered. Next to pre-payment, the banker's documen-
tary letter of credit is regarded, quite rightly, as the most
secure mode of payment that can be chosen.
However, the above statement, although correct, does not
tell the whole story. Regular readers of the export trade press
would be aware that payment by letter of credit often
becomes a contentious issue. The exporter often has pro-
blems with this method of payment — payment being refus-
ed by the bank. The problems are frequently of the ex-
porter's making, although not always; banks can be over-
cautious and documents can quite rightly be rejected if they
bear clauses or notations contrary to the rules governing
the credit or expressly excluded by the instructions given
in the credit.
The exporter who ships out only infrequently against pay-
ment terms banker's documentary letter of credit may not
be aware of the problems he could face. Many of these arise
directly from the relationships of the parties involved in the
transaction.
Before looking further into the technicalities of the credit,
I would draw the exporter's attention to the possibility that
the credit he receives may be worthless. I have no idea how
many fraudulent letters of credit are sent off each year, but
the number is not insubstantial. Sadly, exporters have
despatched against such documents only to find on presen-
tation that they have been duped, that their goods have been
collected from the carrier and the possibility of tracing them
is negligible. Often these credits request the goods to be
airfreighted, so that they arrive at their destination days prior
to the credit being presented to the bank, and the fraud
discovered.
Fraudulent letters of credit may arrive out of the blue. In
these cases the exporter would almost certainly be
suspicious and check them out thoroughly before des-
patching his product. But they may follow from lengthy
negotiation, and euphoria may well temper normal business
prudence.
The quality of fraudulent letters of credit varies widely. Some
are obvious forgeries, others are on the face of it perfect,
and would fool even the most experienced exporter. I would
recommend that all exporters have as policy a procedure
by which the genuineness of all letters of credit are check-
ed with the advising or confirming bank.
It is not only the seller of goods who suffers through
fraudulent transactions. The buyer is at far greater risk than
the seller, for in most cases the exporter will have received
payment before the buyer is able to obtain the goods he
has purchased, and thus be in a position to verify the quali-
ty and quantity as being in conformity with the contract.
Of course, instances of fraud are rare, but there have been
some spectacular cases. Documents such as a certificate
of quality issued by an expert or experts are often requested
by the buyer as protection against goods being despatch-
ed to him which do not conform with his order. This is not
just as protection against fraud, but also against honest
mistakes which could be costly to rectify.
Credits may be revocable or irrevocable, confirmed or un-
confirmed.
From the exporter's point of view a confirmed
irrevocable letter of credit is most favourable because it
can-
not be cancelled by the buyer, and the confirming bank
guarantees payment to the exporter if he presents, together
with the letter of credit, conforming documents to the
con-
firming bank which is usually situated, although not
necessarily, in the exporter's country.
An irrevocable, but unconfirmed, letter of credit offers the
exporter less security. It may not be cancelled, but if the
issuing bank refuses to accept the documents, legal action
may have to be taken overseas, defeating the object of the
credit. A second possibility is that the issuing bank may ac-
cept the documents, but restrictions may be placed on the
transfer of foreign currency out of the country by the Govern-
ment of that country.
A revocable credit may be cancelled by the opener at any
time until it has been utilised. Therefore, it offers the exporter
less security than the irrevocable confirmed or irrevocable
letter of credit and should be utilised with care.
Credits may be at sight or term. Under a term credit, the
exporter does not receive payment against the presentation
of documents, but instead a bill of exchange is accepted
and payment is made only after the period of credit agreed
has expired.
There are a number of special credits. These include
transferable, back to back, also called countervailing credits,
revolving credits and anticipatory credits. The principles and
rules governing these credits are the same as the more usual
banker's documentary credit described in this article.
The main points of variance are:
● Transferable: With this credit the first beneficiary
transfers some of the benefit to one or more secon-
dary beneficiaries If there is more than one secon-
dary beneficiary, the credit will have to allow part
shipments. The credit must allow the corresponding
bank to accept instructions from the first beneficiary
to transfer some of the benefit to the secondary
beneficiaries. The subsequent beneficiaries then ex-
port the goods and present documents in accor-
dance with the credit to the advising or confirming
bank. The bank then calls upon the first beneficiary
to substitute his invoice for those of the subsequent
beneficiaries.
IMDS • JULY/AUGUST • 1985 21
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