INTERNATIONAL TRADE FINANCE– Letter of Credit • Uniform Customary and Practices for Documentary Credits– Standby Letters of Credit– Alternative Methods of Guaranteeing Performance– Alternative Methods of Financing • Seller • Buyer • Government Programs
LETTERS OF CREDIT• Letters of Credit a commercial bank guarantee of either payment by the buyer or performance by the seller. – Purposes • Guarantees payment by the buyer (letter of credit) or to guarantee performance by seller (standby letter of credit. • Once letter of credit is issued, the seller can use instrument to finance production of goods.
LETTERS OF CREDIT• Functions of Letters of Credit – Payment Instrument • In absence of letter of credit, sight or time drafts used. No Guarantee of Payment. – Letters of Credit Involves Bank in Transaction. – Performance Guarantee • In Documentary Transaction no guarantee of performance. – Payment by bank would not be released until goods and document conforms to specifications on letter of credit. – Finance Instrument • Seller can use letter of credit as collateral to finance production and exportation of good.
LETTERS OF CREDIT• Types of Letters of Credit – Irrevocable Letter of Credit-bank cannot revoke letter of credit. To change letter of credit, must get written agreement. • Most Popular in International Commercial Transaction – Revocable Letter of Credit-bank can revoke letter of credit. • Very Seldom Used.
LETTERS OF CREDIT• Letter of Credit Transaction • After formation of contract, buyer arranges for bank to open letter of credit. • Buyer’s bank prepares irrevocable letter of credit. • Buyer’s bank sends irrevocable letter of credit to a US bank for confirmation. • US bank prepares a letter of confirmation to exporter along with irrevocable letter of credit • Exporter arranges for freight forwarded to deliver goods. Freight Forwarder prepares documents. • Exporter presents document to Bank indicating full compliance. Bank bound by “rule of strict compliance” • Bank reviews documents and authorizes payment
UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS• Uniform Customs and Practices for Documentary Credits are rules and procedure published by International Chamber of Commerce – Provisions • Care should be taken in specifying expiration dates • The applicant must specify if the letter of credit is transferable. • The applicant must specify that the letter be confirmed • The currency of the letter of credit should be designated using ISO currency code. • The applicant should designate the nominating bank
UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS• Uniform Customs and Practices for Documentary Credits-provisions continued. – Applicant must specify clearly whether the letter of credit will be available for partial shipment. – The letter of credit should provide transport details – Under “rule of strict compliance”, banks are authorized to reject documents if there are any discrepancies. • Facial Compliance Rule-bank only required to review documents. • Banks are not required to investigate trade customs or usage
UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS• Uniform Customs and Practices for Documentary Credits-provisions continued – Description of the Goods should be clear and brief as possible. – In the listing of documents, should list the contents of each document. – Transportation Documents must be clear. – Insurance Documents must be clear. – Time periods for presentation of documents must be specified. – Title of Letter of Credit should specify irrevocable.
STANBY LETTER OF CREDIT• Standby Letter of Credit is a letter of credit that represents an obligation to the beneficiary on the part of the issuer – International Standby Practices – Standby Letters of Credit secures contractual obligations in construction contracts, service contracts, warranties, counter-trade trade obligations, secures international loans and supplies.
ALTERNATIVE METHODS OF GUARANTEEING PERFORMANCE• Alternative Methods of Guaranteeing Performance – Types • Performance Bond-a guarantee from an insurance company to pay insured in case of default. • Bid Bond-insure against the risk that a bidder may not honor its bid. • Credit Surety-guarantees the repayment to a bank or lender who finances an export transaction or development project. Exim Bank of World Bank
ALTERNATIVE METHODS OF GUARANTEEING PERFORMANCE• Types-Continued – Retention Fund-in large or government projects, a percentage is deducted from each payment due to the supplier or contractor and is retained in a fund pending completion of project. – Demand Guarantee secures performance of a non-monetary obligation.
SOURCES OF TRADE FINANCE• Commercial Banks – Export Financing • Borrowing against trade documents • Factoring-exporter transfers title to its account receivable to a factoring company at a discount. • Forfaithing-selling at a discount, of longer term receivables or promissory notes to a foreign buyer. • Transferable Credit-suppliers accept part of the letter of credit that seller receives from buyer in export transaction. • Back to Back Letter of Credit-buyer makes arrangements with third bank to make loan.
SOURCES OF TRADE FINANCE• Government Assistance Programs – Eximbank in United States- – Arranges loans, guarantees, working capital and insurance – Foreign Corporation Insurance Agency – Protects against default on exports sold under open accounts – Overseas Private Insurance Corporation – Offers performance bonds – Small Business Administration – Revolving line of credit