Letter Of Credit.
A Letter Of Credit, or LC, is usually used with Trade Financing to ensure that the payment transaction of the goods and services between buyers and sellers are satisfied.
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Having it is quite straightforward, for SMEs who are buying goods and those who are selling as well.
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It is an instrument provided by banks in Singapore to facilitate trade settlement.
Usually one of the SMEs, the importer, will use the Letter of Credit from the bank to act as an intermediary to guarantee to the seller that the goods will be paid as per the agreement. This will reduce any risk of payment as it forms such as insurance from the bank. So that in an event the importer fails to make the payment of goods, the bank will be liable to cover the amount of purchase.
The bank issues a written undertaking at the request and in accordance with the instructions of the applicant, in this case, the buyer. The Issuing Bank assures payment to the seller as long as they present documents that comply with the terms and conditions of the LC issued.
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Letters of Credit are useful to businesses that trade in large volumes, both locally and overseas. The main advantages include monitoring the cash flow of the company and lowering the risk of default due to non-payment from the end-customer.
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How does it work in 5 simple steps?
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1) The purchaser takes out a documentary credit with their bank; this is the issuing bank.
2) The issuing bank agrees to pay the agreed amount pursuant to the terms and conditions of the Letter of Credit.
3) The beneficiary then supplies in accordance with the contract and provides their bank with the requested documents.
4) The beneficiary's bank checks the shipment documents and makes them available to the issuing bank.
5) The issuing bank pays the agreed amount to the beneficiary.
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Some main factors on why they are preferred:
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1) They are considered relatively safe
2) They provide clarity
3) It reduces the risk of non-payment
4) It allows flexibility across different types of LC
5) It avoids potential disputes with overseas clients
6) Better opportunity to negotiate with the supplier for better credit terms and pricing
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Letters of credit are very flexible in nature and used in sectors commonly seen from goods shipments to the start-up of large manufacturing plants.
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Conclusion
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Letters of Credit have been playing a critical role in the modern world of global trade, where it allocates risk between the applicant and the beneficiary. With the LC, the beneficiary may greatly reduce the risk of not being paid and ultimately allowing the beneficiary of the letter to reallocate the risk of non-payment for delivered goods. Banks are do not dishonor credit as it may damage the bank's reputation as a credit issuer. Doing businesses in the international market, it provides an important payment mechanism that helps eliminate several trade risks.
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Want to know more?
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Please note, the Letter of Credit is a documentary credit. In other words: The payment commitment of the issuing bank has no value without the covering documents.
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Do you want to find out more about all the aspects and the various Letter of Credit types? Please feel free to contact us, we will be glad to assist you.
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