Drawbacks of Using Letter of Credits in International Trade

Just like there are a huge benefits of using letter of credits in International Trade, there are also drawbacks of Using letter of Credits as well.

If you’ve ever had to fill out a customs form, then you know how complicated and confusing international trade can be. From the names of the products themselves to the amount of paperwork required for each shipment, it’s no wonder that many people avoid trade altogether.

That said, there is a solution—international credit shipments. In fact, most businesses prefer them because they make everything so much easier!

In another post, we discussed that a Letter of Credit (LC) is a document issued by a bank that backs the payment of an obligation of terms already agreed upon between two business entities.

The same post emphasises that the Letter of Credit is usually employed as additional protection during the purchase of inventory and supplies overseas since it requires that all payments must go through the issuing bank before any money exchanges hands, giving more leverage to the buyer because they are able to demand stricter inspections of goods purchased, improved quality control measures, and detailed paperwork notations on what specifically was purchased.

While LCs are generally safe to use, here are some drawbacks you should consider before choosing this financial instrument for your company’s international trade activities:

Drawbacks of Using Letter of Credit

Time Sensitivity

While Letters of credit are typically used in international trade transactions with a long shelf life, they can be quite binding in nature.

For example, the date and time at which payment is to take place must generally be agreed upon and clearly stated by both parties and cannot be changed unless under extreme and rare circumstances where you have the explicit written consent of the issuing bank.

Documentation

Since Letters of Credit are legally binding contracts between two or more companies, it takes careful planning and documentation to ensure the contract will hold up in court should there ever be a legal dispute concerning its terms and conditions.

Costs

Because LCs require intense monitoring by both parties involved due to their time sensitivity, many logistics companies charge an additional fee for this that will make international trade more expensive.

One of the most important parts about protecting your business’s interests is to ensure that you have a clear understanding of what it is you’re signing up for in every aspect of your company’s operations.

Paying for this sort of legal protection can be costly, but in the long run it will be much more beneficial than having to deal with expensive and inconvenient litigation brought upon you by one or many disgruntled former business associates.

Not suitable for Everyone

The biggest drawback to letter of credit transactions is that they’re not suitable for everyone. Unlike other forms of trade, these transactions need to be initiated by the supplier themselves. And while some suppliers don’t mind submitting an application, others either can’t or simply won’t do it under any circumstances.

More paperwork which involves more fees.

Another possible drawback is that, like most other types of trade, there are fees involved with these financial transactions—and you the importer may end up having to pay them. This can be problematic if your shipment isn’t particularly large and you’re tight on money. The reason for this?

Issuing banks charge a commission fee when processing letters of credit, which likely means more paperwork and more time.

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