The Good And Bad About Letters Of Credit
Here we will show you some of the advantages, disadvantages and risks of Letters of Credit (LC)
LC provides some guarantees to the businesses when dealing with financial institutions that other documents would fail to do. Especially when we are talking about exporting goods.
Through the use of LC, a business is more likely to keep the same exchange rates in the course of transactions regardless of the changes that countries do in their currencies. It is not in the best interest of local governments to show the world that the LC are not valid because there were changes in currency.
Irrevocable LC will allow an exporter to easy find sources of financing for its exports.
Depending of what type of LC the exporter has, a company would find it easier to find financing for exports. That is the case of irrevocable LC.
LC benefit the importers because they need to pay for the merchandise it represents, only when the it arrives to a port or airport. In other words, they can be extended as long as the merchandise has not legally arrived to the foreign country.
One of the main drawbacks of LC for importers it the fact that the bank that issued them are often high, and there is also the likelihood that the LC reduces the lines of credit to request other loans.
The main disadvantage of LC for importers is the high prices of that the issuing banks establish. Having one may reduce the possibility of a business to obtain lines of credits.
One of them is the exposure to the changes in currency rates: Companies can be protected against currency fluctuations only to the extent that is specified on the LC. However, there are some fluctuations that would affect the prices of goods within a country and could make them more expensive and on this, LC may not have great influence.
Companies are vulnerable to the fluctuation in exchange rates. Even when LC can give some protection against this issue, it only depends on the economic dynamics of the country. If the prices of certain goods or raw material become higher, the cash flow would be affected in spite of the use of LC.
Exposure to foreign economies: When multinational corporations entering foreign markets to sell goods demand depends on economic conditions in those markets, therefore the cash flows are subject to economic conditions abroad.
LC would provide some stability but provide little guarantees when it comes to political and economic decisions of foreign governments.
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