Treasury management - Letters of credit & International Trade

Question 1

What is the difference between letters of credit and bank guarantees?

Answer 1

A bank guarantee and a letter of credit are similar in many ways but they’re two different things. Letters of credit ensure that a transaction proceeds as
planned, while bank guarantees reduce the loss if the transaction doesn’t go as planned.

Question 2

What is a letter of credit?

Answer 2

A letter of credit is an obligation taken on by a bank to make a payment once certain criteria are met. Once these terms are completed and confirmed, the
bank will transfer the funds.

Question 3

What is a bank guarantee?

Answer 3

A bank guarantee is an instrument that guarantees a sum of money to a beneficiary. The sum is only paid if the opposing party does not fulfill the stipulated obligations under the contract. This can be used to insure a buyer or seller from loss or damage due to non respect of certain conditions or non performance by the other party in a contract.

Question 4

What are some trade risks of conducting business abroad?

Answer 4

-Performance Risk: Risk that the Seller won’t produce and deliver the correct goods on time.
-Payment Risk: Risk that the Buyer won’t pay for the
goods on the due date.
-Bank and Country Risk: Bank credit, foreign exchange controls, civil unrest, trade embargos, etc.
-Regulatory Risk : Compliance, differences in laws, language, local customs, business practices.
-Foreign Exchange Risk: Foreign currency fluctuations.

Question 5

What are some common Trade Payment Methods?

Answer 5

• Open Account payment: Agreement between seller and buyer that payment will be made within a specified period of time, no guarantee of payment.
• Documentary Collections: Banks in the buyer’s and seller’s country act for the seller by presenting commercial documents to the buyer along with a payment demand (usually a bill of exchange).
• Letter of Credit : Buyer’s bank issues an instrument that promises to pay a beneficiary upon presentation of specified documents.
• Confirmed Letter of Credit: LC issued by a foreign bank, confirmed by seller’s bank. Exporter is assured of payment even if the foreign buyer or bank defaults.
• Advance Payment: Funds given by the buyer to the seller prior to shipment.

Question 6

What is the least to most secure method of payment for exporter? (Inverse for importer)

Answer 6

 Open Account
 Documentary Collection
 Letter of Credit
 Confirmed Letter of Credit
 Advance Payment

Question 7

Tell me abut Standby LC / Guarantees

Answer 7

 Financial instrument issued by bank on behalf of its client (or requesting bank) in favour of a beneficiary (3rd party).
 Payment is not expected to be made unless the guaranteed party has
defaulted or has some unfulfilled obligations.
 Paid upon demand; banks are bound only by the text of the LC, not the contract.
 Governed by ICC rules: UCP 600, ISP98, or URDG 758.
 UCP: Uniform Customs and Practice for Documentary Credits. ISP: International
Standby Practices. URDG: Uniform Rules for Demand Guarantees.

Question 8

What are some Common types of Standby LC / Guarantees

Answer 8

Bid Bond/Tender Guarantee:
• To ensure that suppliers submit serious offers, tenders often call for up-front cash
deposits or irrevocable guarantees.
Performance Bond/Guarantee:
• A guarantee for the essential performance of the contract from commencement to
completion. It is for a specified amount of the contract value.
Advance Payment Guarantee:
• Assures the buyer that any advance will be repaid if the seller fails to meet his contractual obligations.
Warranty Guarantee:
• Payment retentions are monies held for a specified period after the completion of a project to cover any defect. The cash holdback can often be replaced by a letter of guarantee.
Financial Guarantee/Standby LC:
• Guarantees a financial obligation such as a payment, loan or lease.

Question 9

What is a Documentary Letter of Credit (LC)

Answer 9

 Undertaking by a Bank to pay the seller upon presentation of documents in strict compliance with LC terms and conditions.
 The seller is assured payment if LC conditions are strictly met.
 The buyer is assured funds will only be released if the seller meets
the documentary requirements.
 Replaces buyer risk with bank risk, risk mitigation for both buyer and seller.
 Banks are bound by the text of the LC, not the contract or goods.
 Governed by ICC UCP 600.
 It is important to bear in mind that a documentary letter of credit is a method of payment which can be used as an efficient and cost effective financing product.

Question 10

What are Documentary Collections?

Answer 10

 Shipping documents and bill of exchange presented through banks as intermediaries.
 Documents against payment (D/P or CAD) / Document against acceptance (D/A).
 Documents delivered to the buyer by their bank only after payment – for sight collection / DP or
 Documents delivered to the buyer by their bank after buyer signs an acceptance to pay – for term collection or DA. No undertaking to pay by buyer’s bank.
 Significant risk for the seller (especially term collection or DA).

Question 11

What are some Benefits of Export Letters of Credit?

Answer 11

Using Export Letter of Credit (LC) for their international
sales enables client to:
 assure, prior to engaged in manufacturing/shipment, that your client
will be paid for goods or services upon shipment/delivery.
 (a letter of credit constitutes a promise by a bank, on behalf of the buyer, to pay the seller or exporter upon shipment/delivery of goods or services, provided the terms of the letter of credit have been met)
 substitute the credit risk of a foreign buyer by that of a bank (generally a better credit risk).
 grant extended payment terms to attract more customers/sales, yet still have the possibility to receive payments much earlier through the efficient and cost effective LC discounting or similar options.

Question 12

What are the Benefits of Import Letters of Credit?

Answer 12

Using an Import Letter of Credit (LC) for your international purchases enables you to:
 Strengthen your relationships with international suppliers by helping those suppliers access bank credit (export LC may be accepted for pre-shipment financing by many banks in Asia, Africa, Europe, etc).
 Extend your payment terms beyond usual Open Account trade terms with the use of usance LC (potentially beyond 3-6 months), yet still allow your suppliers to receive payments much earlier than Open Account term.

Question 13

Tell me about Discounting Export Letter of Credit (LC)

Answer 13

The Negotiating bank may discount the LC, providing immediate payment to the Beneficiary upon presentation of compliant documents.
 Discount rates are typically priced lower than operating loan – LIBOR based with smaller spread as the risk is that of the Issuing Bank.
 Allows Exporter to provide terms to buyers without impacting cash flow.
 Export LC discounting provides additional financing without impacting client’s existing operating facility.

Question 14

Tell me about Bank Guarantees for Export contracts

Answer 14

Bank Guarantee (or more often known as Standby LC in North America) is another Trade instrument commonly used in export contracts of intangible goods/services (e.g. engineering, construction,
technology, etc.).
 If your client is bidding on an international contract, they are often required to demonstrate their performance capability, or ability to meet their contractual obligations, or financial integrity by providing
Bank Guarantee (or Standby LC).
 Most common types of Bank Guarantees for Export contracts include tender guarantee (bid bond), performance guarantee (performance bond), advance payment guarantee.

Question 15

What is an inspector certificate?

Answer 15

Whether you’re the importer receiving new merchandise or you export or sending the merchandise you want someone or an organization that we call at arm’s length. to inspect the merchandise.

Question 16

What does arm’s length mean?

Answer 16

It’s not related to either party. And the decision is impartial.

Question 17

What does partial mean?

Answer 17

Partial means you lean towards one or more than another.

Question 18

If you are worried that the financial institution cannot pay you, you can ask for what?

Answer 18

A guaranteed so it’s either an insurance company or another bank that will come and guarantee the payment of that financial institution. Of course, they will charge you a premium, because it’s an insurance.

Question 19

What is a bitbond?

Answer 19

It’s a document that says that firm in Spain (country) is very reliable. And if ever they don’t provide you with the bid in six months, will pay you $200,000

Question 20

What is a performance bond?

Answer 20

If something isn’t completed in a specific time frame, you might have to pay money.

Question 21

Bitbond and performance bond are used in which common industry?

Answer 21

The movie industry.