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Letters of Credit for Importers

Introduction

A letter of credit (L/C) is the most widely used trade finance instrument in the world. Over 17% of the one trillion dollars of the annual trade between the US and the world is conducted by Letters of Credit. The L/C has been used for the last several hundred years and is considered a highly effective way for banks to finance export and import trade. The letter of credit is a formal letter issued for a bank's customer that authorizes an individual or company to collect a specific amount of money from the bank under certain conditions (ie. providing evidence of product shipment and the release of the title documents for shipped goods). An L/C may be considered a way for an importer to get its bank to substitute the bank's substantial and known credit for the unknown credit of the importer.

Through the use of an L/Cs banks plays an intermediary role to help both Importers and Exporters facilitate the payment of the trade transaction. While the L/C can be used as payment mechanism, it can also be used to provide financing to the importer. Structured Letter of Credit terms such as Deferred Payment and Acceptance credits (i.e. term credits) are considered to be financing instruments for the importer. Both payment structures provide the importer/buyer the time opportunity to sell the goods and pay the amount due with the proceeds.

Copyright © 2004, 2005 Ted S. Eastman. None of the contents of this article may be reproduced or republished without the express permission of the author

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