Question

QUESTION THREE [25]

PAYMENT METHODS FOR TRADING INTERNATIONALLY

There are several basic export payment methods available for international transactions. The amount of trust in the buyer‟s ability and willingness to pay is a major factor that determines the method of payment. Over the years documentary letters of credit have been considered to be a safe mode of payment in international trade for both exporters and importers. Source: www.bizmove.com

In view of the above discuss letters of credit as a payment method in international trade.

Answer 1

Letter of Credit (LC) is by far the most famous and trustworthy mode of payment in international trade across the world. The main risk or contention in an international trade transaction is the buyers and sellers don't actually know each other physically and run low on trust factor on quality of goods to be supplied and probablity of full payment to be received. LC bridges this very gap and hesitation.

LC is essentially a bank document which evens the risk between buyer and seller as seller is guaranteed to receive the payment if it has exactly complied to agreed on terms. In very simple words down below is the payment process :

A buyer of imported goods obtains the letter from his bank before placing an order. This letter is in terms of a guarantee and also a line of credit. The seller of the goods verifies through his bank that the letter of credit is valid and then ships the buyer's order. The seller then takes the required documentation to the bank to collect on the letter of credit, the seller's bank draws the money from the issuing bank, and the issuing bank collects from the buyer. This LC acts as a guarantee to seller that even if buyer defaults the seller will get the money from Issuing bank.

The Buyer's bank is called Issuing Bank AND the seller's bank which approves the LC is Advising bank.

The Issuing bank does its proper due diligence before issuing a LC to the buyer as in the financial capability and business readiness.

THE END

Please let me know in case of any doubt in the answer or any other confusion regarding how LC works.Thanks!! All the best !!