The top 10 most asked questions about letters of credit – A 2022 TFG guide

Estimated reading time: 6 minutes

Here at Trade Finance Global (TFG), we have conversations with a lot of organisations and institutions regarding their letters of credit.

From looking at possible modifications to (and variations of) existing letters to the trade and researching options for new letters, we deal with everyone from funders and banks to businesses.

To help simplify the process, we have put together this list of the questions that we get asked the most often.

The time limit for usance letter of credit

While they are designed in a way to allow for payment deferral, giving more time to the buyer to inspect or even sell the product, local laws in the issuing bank’s country will often define a time period that the letters of credit must adhere to.

This makes it important to be familiar with your individual situation when using a usance letter of credit.

For more information on different types of letters of credit available, and to see what options are available for your business, check out TFG’s letter of credit guide.

Commodities Guarantee

As a general rule, standby LCs are the cheaper option, as they cover less contractually, and have a costlier process involving issuance protocols and document examination fees. This makes LCs the more popular option among traders.

The way that the instruments are used in real-world trade is the key difference between letters of credit and bank guarantees. 

We tend to see merchants involved in the regular import and export of goods using letters of credit to ensure delivery and payments, whereas contractors bidding for infrastructure projects will use bank guarantees to verify their financial credibility.

You can find more information about the similarities and differences between bank guarantees and letters of credit in this TFG guide.

Usance letter of credit and deferred payments

The main parting difference between the two letters is the absence of a draft.

In the usance letter, a draft is included that technically, has no significance to the document or the transaction.

A deferred letter does not include this draft, however, it really makes no difference to either party.

Requirements

Some examples of the required documents for an overseas shipment include:

If the goods are being transported internationally over land borders instead of by sea, the documentation will be different.

For example, you may need to provide a road or rail consignment note that acknowledges the goods have been received by the carrier and are ready for transport.

Revision limits for LC

This being said, in practice, it may not be wise to amend it too many times.

There were once revocable letters of credit.

This type of letter could be cancelled or amended at any time by either the buyer or the issuing bank without any requirement for notification.

This created a lot of complications and led the ICC to remove revocable letters of credit in the UCP 600 from anywhere within their jurisdiction.

Unless all three parties involved can agree to terms, irrevocable letters cannot be cancelled, amended, or reversed.

For more information, check out this TFG guide on the different types of letters of credit.

Relevance of LCs

In some markets, the competition is so strong that buyers are able to demand payment on open account terms.

However, that level of competition is not always present, nor is the possibility of a credit account always technologically possible.

This means that even if most of your trade is done on open account terms, you will still occasionally need to use letters of credit and they will be a vital tool for securing payment and transporting goods.

Furthermore, within the realms of international trade, there are many variables which can contribute to the non-payment in a transaction.

Although an open account allows for deferred payment terms, it does not necessarily guarantee the transaction, which a letter of credit does.

Avalisation explained

It is the involvement of a third party whose role is to guarantee the obligations of the buyer as per the contract.

By ‘Avalising’ the document, they are acting as a co-signer on the contract, and thus share liability.

When companies are trading overseas, the provision of an AVAL may be often necessary to make the instrument eligible for a discount.

Promissory notes are an example of a document that uses the avalisation process.

Technically, a promissory note is a signed document that contains a promise of payment on a specified date.

They are used to source methods of finance that do not include a banking institution although banks can also issue them. 

This third party can be an individual or a company, the only requirement is they are willing to bear the liability.

Since anyone can issue the promissory note, avalisation instils confidence in the transaction.

Factoring vs Reverse Factoring

This third party commits to paying the company’s invoices to the supplier at an accelerated rate in exchange for a discount.

The buyer will pay the provider at the agreed invoice due date, and the supplier receives a much-discounted payment from the factor.

Currencies and Payments

Marine Insurance

The marine insurance documents should reflect whether the contract specified the warehousing of goods.

However, if delivery is at the port then the standard insurance will terminate there.