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Export Letter of Credit

Updated on May 11, 2024
Article byKumar Rahul
Edited byKumar Rahul
Reviewed byDheeraj Vaidya, CFA, FRM

What Is An Export Letter Of Credit?

An Export Letter of Credit (ELC) is a financial document issued by a bank on behalf of the importer (buyer) to guarantee payment to the exporter (seller) for goods or services. It serves as a secure method of payment in international trade transactions.

Export Letter of Credit

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From a financial perspective, the primary aim of an export letter of credit is to mitigate the risk for both the exporter and the importer. For exporters, it ensures that they will receive payment for their goods or services once they meet the terms and conditions specified in the LC. This reduces the risk of non-payment or default by the importer. 

Key Takeaways

  • An Export Letter of Credit is a financial instrument issued by a bank on behalf of a buyer to guarantee payment to a seller for goods or services.
  • Export LCs provide a secure method of payment for exporters. It ensures they receive payment upon fulfilling the terms and conditions specified in the LC.
  • LCs mitigate the risk of non-payment or default by importers. The issuing bank guarantees payment upon presentation of compliant documents.
  • Export LCs provide standardized terms and conditions agreed upon by both parties. It reduces the potential for disputes or misunderstandings in international trade transactions.

How Does Export Letter Of Credit Work?

An Export Letter of Credit (ELC) is a financial instrument that acts as a guarantee of payment for goods or services in international trade. It works by involving three main parties: the exporter (seller), the importer (buyer), and the issuing bank.

First, the importer and exporter agree to the terms of the sale, including price, quantity, and delivery terms. Then, the importer requests their bank to issue an ELC in favor of the exporter. The issuing bank, after assessing the creditworthiness of the importer, issues the ELC, promising to pay the exporter a specified amount upon presentation of compliant documents proving shipment or delivery of the goods as per the terms agreed upon.

Next, the exporter ships the goods. They gather the necessary documents, such as invoices, bills of lading, and certificates of origin, as stipulated in the ELC. The exporter presents these documents to their bank, known as the advising bank. The advising bank forwards them to the issuing bank. Upon verification that the documents comply with the terms of the ELC, the issuing bank releases payment to the exporter. If the documents are complete or correct, the payment may be delayed or rejected. This assures the importer that payment will only be made upon satisfactory completion of the transaction. 

Process Steps

The export letter of credit technique entails numerous steps:

  1. Agreement: The exporter (seller) and importer (buyer) agree on the terms of the sale, including price, quantity, delivery terms, and other relevant conditions.
  2. Request for LC: The importer requests their bank (issuing bank) to issue an ELC in favor of the exporter to guarantee payment for the goods or services.
  3. Issuance of LC: The issuing bank evaluates the creditworthiness of the importer and issues the ELC, specifying the terms and conditions of the transaction, such as the amount, expiry date, shipping terms, and required documents.
  4. Advising the LC: The ELC is transmitted to the exporter through their bank (advising bank), which verifies the authenticity of the ELC and informs the exporter about its existence and terms.
  5. Shipment of Goods: The exporter ships items that are consistent with ELC terms.
  6. Document Preparation: The exporter gathers the required documents in a consistent manner with ELC.
  7. Presentation of Documents: Exporter submits documents to advising financial institution.
  8. Document Examination: Advising financial institution forwards files to issuing financial institution for scrutiny.
  9. Payment or Rejection: The issuing bank releases payment if the documents comply; in any other case, it might also reject or request corrections.
  10. Closure of LC: Once the fee is made, ELC is closed, and the transaction is concluded.

Examples

Let us understand it better with some examples:

Example #1

Suppose a textile manufacturer in India is exporting a shipment of fabrics to a retailer in the United States. The importer requests their bank in the U.S. to issue an export letter of credit in favor of the exporter. The ELC specifies the quantity, quality, and delivery terms of the fabrics, along with the required shipping documents. After the fabrics are shipped and the exporter presents compliant documents, the issuing bank verifies them and releases payment to the exporter. This process ensures a secure transaction for both parties, facilitating smooth international trade. 

Example #2

In 2024, Saudi Export and Import Bank (Saudi EXIM) has inked a groundbreaking deal with Saudi Basic Industries Corporation (SABIC), ensuring SABIC’s sales in 40 countries on a letter of credit basis. This move hailed as the most significant policy ever in the Middle East, safeguards against non-payment risks from issuing banks. Offering direct insurance to exporters for unconfirmed ELCs opens avenues for growth and market penetration. The agreement, signed by Saudi EXIM CEO Saad Al-Khalab and SABIC’s Salah Al-Hareky, underscores Saudi Arabia’s commitment to diversifying its economy and boosting non-oil exports, aligning with Vision 2030 objectives. 

Advantages And Disadvantages

Below is an outline of the advantages and disadvantages of export letter of credit:

AdvantagesDisadvantages
1. Payment security for exporters1. Complexity and strict documentation
2. Mitigates risk of non-payment or default2. Costs associated with LC processing
3. Standardized terms reduce disputes3. Risk of discrepancies in document submission
4. Enhances creditworthiness of exporter4. Dependence on banks for payment processing
5. Facilitates global trade transactions5. Limited flexibility in terms of conditions

Export Letter Of Credit vs Import Letter Of Credit

A few ways that export and import letters of credit differ from one another are as follows:

AspectExport Letter of CreditImport Letter of Credit
DefinitionPayment guarantee for exportersPayment guarantee for importers
InitiatorExporterImporter
PurposeEnsures payment upon fulfilling export obligationsEnsures payment upon receiving goods
Issuing BankLocated in the importer’s countryLocated in the exporter’s country
Document RequirementsShipping documents, invoices, certificates, etc.Import license, bill of lading, inspection reports, etc.
CostIncurred by the importerIncurred by the exporter
Risk MitigationReduces risk of non-payment for exportersReduces risk of non-delivery or non-compliance for importers
FlexibilityLess flexible as terms are dictated by importerMore flexibility as terms are dictated by exporter
Impact on Cash FlowMay delay payment until documents are verifiedLess flexible as terms are dictated by an importer

Frequently Asked Questions (FAQs)

What is the price of acquiring an export credit letter?

The cost of obtaining an Export LC varies depending on factors such as the issuing bank, the complexity of the transaction, and any additional services required. Costs may include issuance fees, amendment fees, confirmation fees, and other related charges.

What risks are there with export letters of credit?

Risks associated with Export LCs include the possibility of discrepancies in documents, delays in payment processing, dependence on banks for payment, and limited flexibility in transaction terms.

Are export letters of credit typically used in international trade?

Yes, Export LCs are common in international trade transactions, especially when dealing with unfamiliar or high-risk trading partners. They provide a secure and trusted method of payment for exporters and importers alike.

This article has been a guide to what is an Export Letter Of Credit. We explain its process steps, comparison with import LC, examples, advantages, and disadvantages. You may also find some useful articles here –

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