Financing and Securing International Trade Transactions

When an exporter in one country sells goods to an importer in another country, both sides face a genuine trust problem that rarely exists in a purely domestic sale. The exporter does not personally know the importer's financial standing, cannot easily verify creditworthiness across a border, and worries about shipping goods without any assurance of payment. The importer, in turn, does not want to pay in advance for goods that might never arrive, or might arrive in the wrong quantity or condition. Two long-established instruments have grown up specifically to bridge this trust gap and to help finance the transaction in the meantime: the Letter of Credit and the Bill of Exchange.

A Letter of Credit is essentially a formal guarantee, issued by a bank on behalf of the importer, promising the exporter that payment will be made once the exporter presents the specific shipping and other documents named in the credit (such as the bill of lading, invoice, and insurance certificate) within a stated time and exactly as required. Because a reputable bank -- not the individual importer -- stands behind the promise to pay, the exporter can ship the goods with far greater confidence, and the importer does not have to pay anything until the agreed documents actually show that the goods have been shipped as promised. The main parties usually involved are the importer (who applies for the credit), the importer's bank (the issuing bank, which opens the credit), and the exporter (the beneficiary who is to be paid); an advising or confirming bank in the exporter's own country is often also involved to pass on and, where required, add its own guarantee to the credit. Because of this structure, the Letter of Credit is widely regarded as one of the safest and most commonly used methods of settling international trade payments. …