Cheques, transfers, bill of exchange, documentary bill, documentary collection, letter of credit, guarantees, import and export financing.

Under a letter of credit, the bank engages itself to pay a beneficiary in accordance with documents presented by the seller. In a documentary collection, banks act like “mailboxes”; they transmit documents to their client while following the payment instructions received.

An LC is an international means of payment used to settle buying or selling under a contract upon fulfillment of contractual obligations making it a payment instrument. An SBLC is a guarantee (of payment) that is called upon when ordering party is unable to fulfill its contractual obligations making it a default instrument.

Whether it is on payment date or for defaults, both require payment to be made against documents to be presented within a valid period; documents are valid if they appear to be compliant.

Irrevocable, irrevocable and confirmed, transferable, back-to-back, revolving (renewable), red clause, green clause.

Advantages?

On imports: Pay the vendor when his contractual obligations are completed. On exports: A secured payment with no consideration of the country or counterparty risk.

Drawbacks?

Payment is due if documents are in line with the contract. There is no commitment on the compliance of goods.

Advantages?

• Simpler and faster, therefore easier to sell to customers than LCs.
• Buyer can only get documents of title to the merchandise either upon payment to the bank of the amount owned or upon acceptance of a term bill of exchange the cost is low because it does not require a payment commitment by banks
• Suitable where seller is comfortable with the buyer and country risk of buyer but still wants to ensure payment

Drawbacks?

• Political risk for the vendor / provider
• Banks are not undertaking any risk.
• Default risk from the buyer: buyer may use several arguments not to pay.

Advantages?

Easy to process and simplicity of gathering documents certifying the non-compliance on the part of the exporter’s obligations.

Drawbacks?

Paym ent under a guarantee usually requires a simple certification to enforce payment and therefore can be subject to misuse.

An irrevocable and confirmed LC is not only a means of payment but a guarantee protecting the vendor from both solvency risk of the buyer and country and issuing bank risks. An unconfirmed irrevocable documentary credit is limited in the sense that its security does not protect completely the seller from the risk of non-payment / default. In addition to this constraint, payment could take longer if made at the counter of the ordering bank.

A transferable LC allows the first beneficiary of the LC to transfer all or part of its rights to another beneficiary who is supplying the actual goods.

Advantages?

Subcontractors are secured, no cash outflow for intermediaries, and flexibility and confidentiality

Drawbacks?

The main one is to structure this type of letter of credit. It is highly recommended that subcontracts should be aligned with the main contract (currency, transportation mode, incoterms, and documents). Else, transaction could malfunction.

• Costly, charges are supported by the subcontractor.
• Quality control certifications requested by ordering parties and furnished by inspection establishments and third holders are barely used on this type of LC. What is the certified pricing in case subcontractor is the one sending the goods? Is it subcontractor’s pricing or the first beneficiary? What about confidentiality clauses in these cases?

A back-to-back LC can be used where the first beneficiary is not the actual supplier. The first beneficiary will request his bank to issue a second LC to the actual supplier. The two LCs are however independent LCs with their own terms and conditions. The first LC is normally offered as security for the second LC.

Advantages?

• Subcontractors are secured
• Easier to manage treasury for vendors, confidentiality
• Internationalization (the beneficiary of a back to back can be located in a country different from that of the seller)

Drawbacks?

• Heavy costs
• Highly complex structure and risky
• There are several parties involved making it difficult to manage any changes to the LCs
• High risk for the issuing bank, if one of the parties goes bankrupt or if the beneficiary of the first LC does not perform, the issuing bank must still honor its obligations to the beneficiary of the second LC yet it cannot obtain payment under the first LC.

It is available for an amount and allows that amount to be reinstated automatically under certain circumstances without need for amendments to the LC.

Advantages?

• Buyer can use one LC to cover multiple shipments over a long period of time instead of opening an LC for each shipment
• Simple, quick and less expensive
• Automatism

Drawbacks?

Partia l shipments are allowed but the ordering customer must bear in mind that amending this type of credit is complicated. He should therefore be meticulous regarding renewal conditions.

A specific type of letter of credit in which a buyer extends an unsecured loan to a seller. Red Clause Letters of Credit permit documentary credit beneficiaries to receive pre-shipment financing from the bank nominated in the Letter of Credit for any merchandise outlined in the letter of credit. Financing costs are borne by the LC beneficiary but the nominated bank takes the risk of the LC issuing bank. These letters are commonly used by beneficiaries who act as purchasing agents for buyers in another country. It is then an additional risk for the buyer who finds himself depending on the successful implementation of the beneficiary finally placing him in the position of an unsecured creditor.

The “green clause” LC follows exactly the same principle as the red clause one except that advance payments will be made only against presentation of documents proving the existence of goods (warehouse and freight receipts, inspection certificate).
Advance payments are usually made before shipping goods that are also pledged to the issuing bank. This type of LC is also less risky to the buyer than the “red clause” one to the extent that the goods constitute a guarantee of repayment of advances made, in the case where the beneficiary does not present the required documents in the documentary credit.

For more information and enquiries, please email: Ecoban kTradeSales@ecobank.com