This document discusses the risks involved in international trade finance and letters of credit. It identifies macro risks like country risk and foreign bank risk that influence credit limits. Transaction risks depend on the financial status of the buyer, goods, and counterparty. The role of banks is described, including specialized risk units, credit limits, and guarantees. Common causes of letter of credit discrepancies are outlined relating to documents, invoices, bills of lading, insurance, and other areas. Checking the workability of letter of credit terms and conducting due diligence on counterparties are recommended.

1. LETTER OF CREDIT RISK
MANAGEMENT
Maria Luís Andrade

2. Main Areas of Risk in International Trade
Finance
TRANSACTION RISKS: INTERNAL FACTORS
WHICH MAY INFLUENCE THE PERFORMANCE
OF THE TRANSACTION
MACRO-RISKS: EXTERNAL RISKS WHICH MAY
HAVE A NEGATIVE IMPACT IN INTERNATIONAL
TRADE TRANSACTIONS

3. Macro-Risks Define the Credit Limit to
deal with these countries
and banks
Analyse Foreign Bank´s Risk
Analyse Country´s Risk

4. Macro-Risks
Country´s Risk
1. Political and
economic stability
2. Foreign debt
commitments
3. Track record in
meeting past
commitments
4. Exchange
controls
5. Regulatory
measures to
protect domestic
industry
Foreign Bank´s risk
1. History of delaying
or actually payment
default
2. Having a habit of
rejecting documents
with trivial
discrepancies
3. Being domiciled in a
country with foreign
exchange restrictions
4. Being domiciled in a
country classified as
high risk
Transactions Risks
1. Financial
status of the
applicant/buyer
2. The goods
3. The
counterparty

5. The role of the Bank
Banks are mostly intermediaries: they are responsible for the financial aspect of the
transaction.
They are not legally liable for the authenticity of the goods; however, they have the
duty of due diligence and the obligation to pay upon proper receipt of the required
documents

6. The role of the Bank
Most banks have specialized units which handle country risks.
These units set and control the degree of exposure that a bank will
be willing to take in each country it deals with.
Banks usually try to specialize in specific regions or countries.
All international trade transactions involve the participation of
one or more foreign banks. Yet, not all such banks have the
same degree of stability and strength.

7. The role of the
Bank
There is always a margin of
flexibility to deal with higher-
risk countries or banks,
provided that an additional
guarantee can be supplied or a
recourse to a better-rated third
party can be obtained.
If the country is
risky, the banks
will either:
Reduce
the credit
limits
Or
increase
the rates
charged

8. The role of the
Bank
For smaller companies the bank would
normally ask for a personal guarantee
(rights on a trader’s house for
example) or try to split the risk, by
taking goods as a security (up to 75-
80%) on the loan and take the rest in
fixed security.
In some cases banks refuse to take any
risk and therefore deal only on a fully
cash basis until trust is established with
the new client.
Before accepting to open a letter of credit, the banks in
general will conduct research on their clients, examine their
financial records, ask for references from other clients, use
outside references, and check the track record of the
company. This is to ensure that the customer has or is likely
to have enough funds to pay for the documentary credit
For a new client, the bank would generally ask for a
guarantee.

9. The Goods
The credit limit that a bank
makes available for a trader is
greatly influenced by these
three variables
type of commodity (soft or hard
commodity, perishables)
the market (does the commodity
have a ready market with legitimate
buy/sell offers)
the commodity’s price volatility.

10. The Goods
Price volatility
brings large credit
risks
Buyer would be tempted to
breach his contract in case of a
price decrease and therefore use
any discrepancy in
documentation as an excuse to
avoid payment.
Importer would have difficulties
to cover his credit since the
merchandise he bought has a
lesser value than what it cost
him.

11. The Goods
Foreign
Exchange
Exposure
Price
fixation
Hedging
techniques
Suitable
insurance
(Sources of risk and mitigation)

12. Important Bank-Counterparty engagement
◦ Importer´s bank:
◦ Might be entitled to choose the
business channel through which
it is willing to deal (i.e.,
confirming or advising banks)
◦ Exporter´s bank:
◦ Advises the exporter on the
documentary credit it receives in
his favor from an overseas
bank(issuing bank).
◦ Check carefully whether the
overseas bank is reliable.

13. Important Bank-Counterparty engagement
◦ It is very important for a commodity firm to select carefully the bank that it
wants to do business with. Its selection criteria should include:
The bank's regional, country and commodity specializations
The relation between costs and service.
Fees (bank charges) and even interest rates vary widely from bank to bank and
should be negotiated.

14. Important Bank-Counterparty engagement
Seek for a bank that may offer a good range of financing methods and
structured finance options:
1. Pre-export finance based on letters of credit;
2. Warehouse receipt finance;
3. Factoring and forfeiting;

15. Important Bank-Counterparty engagement
Traders need to have a good knowledge of the other contracting party. The role
of the bank at this level is:
1. To identify their client’s/buyer’s financial ability, integrity and reputation.
2. To identify all the possible banking facilities available overseas for negotiation,
presenting a comparable range of fees involved in the financial transaction.
 The final objective is to get a clear setting of the credit risk he will have to
assume.

16. How to obtain reliable information about the
counterparties
 Local chambers of commerce of the country concerned
 Using investigation of specialized companies such as Dun and Bradstreet/CRIF
 Bank references
 Trade/commodity associations (membership in a trade/commodity association is a good indication of a
company’s standing in a market as some associations may suspend members who have made any unlawful
practices).

17. Important Bank-Counterparty engagement
 Banks should have an advisory role
on the documentary requirements
that come with a letter of credit:
• Commercial Invoice
• Bill of lading
• Certificate of origin
• Inspection certificate
• Packing list
• Dock receipt and warehouse
receipt
• Insurance certificate
• Import/Export licenses
• Phytosanitary certificate
These documents should be strictly
limited to what is necessary for the
proper conclusion of the deal.

18. Important Bank-Counterparty engagement
Banks should create awareness on the workability of a letter of credit:
Will the exporter be able to comply with its terms and conditions?
(very often exporters discover that they cannot produce a compliant set of documents under a proposed
documentary credit).
?

19. Workability of the LC
It is essential for every single trader to put in place
their own check procedures to assure the workability
of the LC and the revision of the documents required
to the documentary credit.
This is even more important for the documents
not issued “in-house” but through the
collaboration of a third-party entity, instead.

20. Important check-points
◦ The next slides comprise a compilation of
the most common causes of discrepancies
taken from “Documentary Credits”, issued
by Midland Bank plc, HSBC Trade services.
◦ They might be a good foundation to
prepare a customized checklist adapted to
the reality of each trader.

21. Most common discrepancies in letters of credit
1. In relation to time:
1.1 Credit expired
1.2 Late shipment
1.3 Late presentation
2. In relation to the documents, in general:
2.1Non-compatibility/inconsistency of the information in the documents
(contradiction between the documents)
2.2 Original documents not marked “original”
2.3 Document(s) unsigned
2.4 Documents submitted late to the bank. (Banks will not accept documents
presented to them later than 21 days after date of shipment, unless otherwise
stipulated)
3. Related to the invoice
3.1 Terms of shipping not clear (Incoterms)
3.2 Issued for wrong amount, or for an amount greater than the credit value
3.3 Issued with terms of payment and currency not clearly stated

22. Most common discrepancies in letters of credit
3.4 Not signed/certified/legalized (when credit calls for signed invoices)
3.5 Omits the goods description, as detailed in the credit (different description)
3.6 Shipping marks differ from transport documents
4. Related to the bill of lading:
4.1 Does not indicate the name of the carrier
4.2 Does not clearly define consignee, shipper, or notifying party
4.3 Weights and measurements differ from other documents
4.4 Not signed in accordance with the requirements of UCP 600
4.5 B/L claused (“foul” B/L) showing defective goods or packaging, (e.g. “rusty”,
“leaking drums”,etc.)
4.6 Goods shipped on deck
5. Related to insurance
5.1 Certificate presented in lieu of a policy
5.2 Dated after date of shipment (coverage effective after the transport date)
5.3 Omission (on its face) of risks covered

23. Most common discrepancies in letters of credit
5.4 Insured value insufficient
5.5 Absence of endorsement
5.6 Certificate issued under an expired policy
5.7 Not issued in negotiable form
6. Related to certificates:
6.1 Incorrectly titled
6.2 Content not as called for
6.3 Not signed
7. Miscellaneous documents
7.1 Omit to present certificate of origin as required by the letter of credit
7.2 Omit to sign (or seal by a Chamber of Commerce) certificate of origin
7.3 Packing list not conform to the importing country’s requirement
7.4 Draft drawn on the wrong party
7.5 Draft drawn for the wrong amount
8. Other common discrepancies
8.1 Goods shipped by sea instead of by air (or vice versa)

24. Most common discrepancies in letters of credit
8.2 Amount claimed exceeds the credit value
8.3 Partial shipment or transhipment effected when not allowed
Suggestions of reading:
https://icc.academy/11-questions-that-will-help-you-master-documentary-credits/
Alavi, H. (2018) "Delivery Terms in Transport Process of Export Trade and Their Effect on the Risk of Discrepancy in Documentary Letters of Credit; Evidence
from Estonia.", International Journal of Commerce and Finance 4.1
Alavi, H. (2017) "Risk Analysis in Documentary Letter of Credit Operation." Financial Law Review 0.0: Financial Law Review, 04/18/2017, No.1 (4)
Hao, Y., Xiao, L., (2013) “Risk Analysis of Letter of Credit -Based on Principles of Independence and Strict Compliance.” International Journal of Business and
Social Science Vol. 4 No. 9, pp. 199-209

25. THANK YOU!
https://www.linkedin.com/in/maria-andrade-09b8b03b/