Letter Credit and Its Essence

The customer entered the banking hall weeping uncontrollably and entered the Branch Manager's office. The staff and customers alike were at a loss as to what had really happened. For some five minutes, the client could not open his mouth to say anything, but was in deep thought. Finally, he let the cat out of the bag. He had been duped by a Kenyan friend.  The US $30,000 he withdrew some two weeks ago - all gone. The Kenyan friend had promised to help him import some goods from South Africa, for the impending Christmas season. It is now two weeks and the Kenyan friend is nowhere to be found.

The customer had been ill advised to ignore the bank making such remittances as their charges on such transactions were too high. On this fateful day, the customer had made this withdrawal of $30,000 against all pleading to transfer by SWIFT to a correspondence bank in South Africa, claiming our charges were too high. He again ignored our advice to send a letter of credit to his supplier in South Africa. Finally we succumbed to his demand for the withdrawal of the foreign currency. Most clients of banks who deal with business partners outside the country are ignorant of the important service of   letter of credit rendered to business customers. What is letter of credit?

LETTER OF CREDIT

Before I touch on the real issues of the topic, I want to briefly mention problems and fears of the clients who do business direct with business partners outside the country:

1.  Exporters are always in constant fear that goods sent outside may not receive

     payment promptly and therefore would like business partners to send payment in

     advance before goods are delivered.

2.  Importers are also in constant fear that when payments are made in advance,

     goods may not arrive on time or even goods may not be of required specifications.

3.  There is always a conflict between exporters and importers, when economic activity

     takes place and one party feel cheated, the way out of arbitration becomes difficult

     because of different laws  that apply in their respective countries.

This is where a letter of credit comes in. This is a simple letter written by the importer's banker, on behalf of the importer, to the exporter through his banker, requesting that ''should the exporter produce and send goods according to required specification attached, payment would be made".

Here, the two banks, serving as agents for their clients (exporter and importer) ensure that the tenets of the letter of credit is strictly adhered to and this is governed by the International Chamber of Commerce.

THE PROCESS OF LETTER OF CREDIT

1. Exporter and Importer agree on economic deal and do business

2. Importer applies to his banker for a letter of credit and delivers specification of goods.

3. The importer's banker sends letter of credit to exporter's banker

4.  The exporter's banker convey message of the letter of credit to the exporter

5. Exporter immediately produces goods and send to the port for shipment 

    to destination country via high seas

6.  Exporter sends copies of Bill of Lading to his banker who cross checks 

     to ensure goods have met specification.

7. Bill of Lading is sent by air to the importer's country and payment is immediately effected.

BENEFITS OF A LETTER OF CREDIT

1. The exporter happily delivers goods without any fear of default.

2. The exporter, as soon as a letter of credit is received, can obtain credit

   from his bank to Pre-Finance  production of goods.

3. The importer's fear of delivery not according to specification or shoddy 

    Goods is completely defeated, because both banks become vigilant on 

   Documentations.

4.  The importer, having struck an economic deal can start savings until goods 

      arrive, or even   ask for a top up before goods arrive.

5. The two banks of both the exporter and the importer also get their 

    Commissions, as well as win 100% client loyalty.

       source;essienthebanker.blogspot.com