LCs Letters of Credit

last updated 2005 July 08
 
 

INTRODUCTION

The subject of LCs is not normally something you would teach in a general overview course on International Business Management - but for some people who are interested in actually becoming involved in exporting and importing, LCs are a necessary thing which you must understand. Major banks handle LCs for small, medium and large sized customers. Most banks have websites in which there is a lot of educational information to assist people. Canadian banks have some good sites describing and explaining LCs. For the purposes of this course, we will direct students to the material on the RBC site , some of which is shown below. WTGR

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What are LC s

"Letters of Credit are guarantees of payment to help you make purchases or transact business with companies with whom you have limited trading experience or credit history." wachovia.com   Basically, if you are an importer, you don't want to send the money before you get the goods. The exporter, doesn't want to send the goods to you, unless they get their money. So an LC tells a 3rd party in-between that "yes, the buyer has the money, they gave the money to me, once the stuff arrives safely at the other end, and is confirmed to be what it is supposed to be, I'll give the money to you, the vendor" Usually banks play the role of the 3rd party since they are insitutions recognized to be trustworthy for this sort of thing, and they sometimes also obliged to convert the currency as well - which banks can take care of. The bank will also charge a fee for the service and this is just one of the ways banks make money in the field of international business. WTGR

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Canadian Banks  and  LCs

Medium and large sized companies that are importing and exporting on a monthly or weekly basis use a lot of LCs and this can mean big business for a bank, particular a Canadian bank that has a big exporter as a client, like Nortel or Magna. To be competitive, and constantly attract new customers who are growing their business, the major banks in Canada have sections on their websites in which they explain import and export terms and processes. Royal Bank has a particular useful site. Vincent Barboza, Regional  Manager, Trade Finance, International Trade Centre of RBC told Tim Richardson in a July 2005 email about some RBC webpages that were pertinent to LCs and provided the URLs you can see below. WTGR

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basic forms of letters of credit

the Credit Research Foundation has a simple explanation of the two basic forms of letters of credit:  Standby and Documentary see  http://www.crfonline.org/orc/cro/cro-9-2.html  Standby Letter of Credit (often called non-performing letters of credit) Documentary Revocable Letter of Credit Documentary Irrevocable Letter of Credit        Two forms of irrevocable credits:             o Unconfirmed credit             o Confirmed credit Special Letters of Credit             o Back-to-Back Letter of Credit             o Deferred Payment (Usance) Letter of Credit             o Red Clause Letter of Credit             o Revolving Letter of Credit             o Transferable Letter of Credit

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from the RBC web site. a great list explaining the process for a simple LC.

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from the RBC web site. a great list explaining the different types of LCs   Irrevocable credit Revocable credit Confirmed credit Transferable Credit Standby Letter of Credit

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KEY POINTS

For the purposes of MGTC44, it is not critical to memorize the different types of LCs, rather it is suffice to understand that different types do exist for the purpose of different payment circumstances. WTGR

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Problems with using LCs

Common Problems with Letters of Credit One of the things that is important for students of management to understand about business and international business is that the "real world" very seldom operates as precisely as the theory in the classroom. In the real world, there are often problems with "satisfying" the requirements of an LC on the side of the sender (seller), and the receiver (buyer). If an LC is irrevocable (meaning the credit cannot be amended or canceled without the agreement of all parties) then the buyer may have a big problem if something develops that they cannot fix - because the 3rd party will be obliged to pass the money to the seller once the goods are landed. Ron Borcky explains "Sellers may have one or more of the following problems:   The shipment schedule cannot be met weather extremes mechanical or IT breakdown border crossing delayed The stipulations concerning freight costs are unacceptable; The price becomes too low due to exchange rates fluctuations; The quantity of product ordered is not the expected amount; The description of product is either insufficient or too detailed;  which effects the customs classification and the tariff applied The stipulated documents are difficult or impossible to obtain." export permits permit for hazardous materials permission for the truck to cross some int'l border attributed to Ron Borcky from  http://www.crfonline.org/orc/cro/cro-9-2.html

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Contact has been made by email with
Royal Bank - Beja Rodeck, Sr. Mgr, Media and Public Relations and Vincent Barboza, Regional  Manager, Trade Finance, International Trade Centre,
for permission to quote from their site, and use screen captures
copies of emails are kept in the permissions binder

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