Letter of Credit in International sales transactions
A Letter of Credit is the traditional worldwide risk management tool for international transactions. It is used in transactions between seller and buyer as a method of payment (through the bank). In such transactions, the bank is responsible to ensure that the correct amount will be paid on the correct time. In this way, both the buyer and the seller are protected. Moreover, the bank does not give the money to the seller until it receives a confirmation that the goods have been shipped. This form of payment seems to me very logical as it guarantees a secure transaction system, which is essential in international sales field.
Furthermore, this method of payment requires the buyer to choose the issuing (opening) bank and set up the letter of credit which he then sends to the seller. At this stage, the letter must be confirmed by the seller’s bank. A full diagram of this procedure can be seen below.
Besides, Letters of credit can be revocable or irrevocable.
Revocable is the letter of credit which can be modified or cancelled at any time by the bank, which represents the buyer, without the approval of the seller. It should be noted that this can occur even when the goods are shipped. As this does not ensure the seller, whether he will be paid or when, it is rarely used. Also, some banks avoid issuing such letters from fear of being involved in any possible litigation.
Most banks and sellers prefer the issuing of irrevocable letters of credit which is less risky for them. Irrevocable letters cannot be amended or cancelled without the consent of the seller. Consent should be given by all affected parties (such as banks).
I believe that the letter of credit is a very significant factor in international sales transactions. When considering that every country has its own laws and currency and also the fact that the distance makes it difficult for the parties to know each other, then the letters of credit are a wise solution.
Further Reading:
http://www.loanuniverse.com/letters.html
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