“In modern business practice, a letters of credit also known as a Documentary Credit, is a written commitment by a bank issued after a request by an importer that payment will be made to the beneficiary” … Wikipedia
“The seller of the goods verifies through his bank that the letters of credit that was issued by the buyer through his bank is valid and then ships the buyer’s order in line with agreed specifications. The seller then takes the required documentation to the bank to collect on the letter of credit, the seller’s bank draws the money from the issuing bank, and the issuing bank collects from the buyer”. smallbusiness.chrom.com
Letters of Credit are backed by international laws, they are used mostly for international trade, adequate care must however be taken in providing information to your bank as expensive mistakes can be made in the process.
The importer’s bank must have arranged a credit line with a correspondent bank whom the exporters bank is comfortable with. It is only on the strength of the credit that the exporters bank will give comfort to its customer that he will be paid once he performs in line with agreement.
LCs are flexible and can be amended during the life of the arrangement (At a cost mostly to the importer/buyer).
The banks takes the role of a disinterested party and does not take sides. They make the fund available to the exporter/seller only when spelt out conditions are met. The banks involved are very cautious of their reputations and ensure strict adherence to global LC rules.
Here are 4 reasons why you should use Letter of Credit (LC)
1. Your exporter/seller will not be paid until your good are confirmed shipped.
One of the very important aspect of an LC arrangement is that it offers protection for the importer as much as it offers to the exporter. Your bank will give the exporters bank the go-ahead to release money to the exporter upon receipt of the shipping documents which signifies that your good have been shipped.
2. Your exporter will have the guarantee of his bank that he will get paid once he performs.
Your exporter/seller will be motivated to performs in line with agreed specifications once an LC is established. He will not need to worry about being paid as neither you nor him can cancel the transaction without a genuine reason once an LC has been established.
3. Your importation will be properly insured
Part of the condition for establishing a letter of credit is that there must be marine insurance in place to protect the imported good. It is part of the responsibility of your bank to ensure that this is done in other to helps mitigate the risks associated with importation of goods across international borders.
The importer is most hit if anything happens to the importation once it has been shipped as the exporter is seen to have have performed and may have been paid immediately the shipping document is received by the exporters bank.
4. You will get you money back if the exporter fails to perform.
The importer can call for a refund of his money if the exporters fails to perform and the same money can be made available to another supplier who he deems comfortable with. As the importer you can insist on inspection certificate as part of the document sent by the seller to you bank before your bank authorize payment. This will enable you to verify that you are getting value for your money.
To get an LC you will need to first agree with your business partner and agree on LC as a means of payment for your goods. Then contact your bank.
Most, if not all Nigerian banks offers LC. Some customers liaise with the foreign trade department of their bank directly for easy processing of their LC transactions