Letter of credit and its characteristics
1. Letter of credit is a kind of bank credit, the issuing bank has the first payment issuing bank after issuing the letter of credit, as long as the exporter submits the documents in accordance with the terms of the letter of credit, the issuing bank must fulfill the payment responsibility.
2. Letter of credit is independent of the contract of sale and purchase and is not bound by the contract of sale and purchase. Although the letter of credit is opened based on the contract of sale, it is different from the contract of sale, it is independent and is only a promise of the issuing bank to the exporter to guarantee payment.
3. Letter of credit is a documentary business. The bank relies on the documents delivered, regardless of the actual delivery of the goods. As long as the documents meet the requirements of the terms of the L/C, the bank shall pay unconditionally.
Why risk arises
Before L/C, the way of international trade settlement was mainly remittance and collection. Since the transaction was based on commercial credit, there were certain risks for both buyers and sellers, which affected the development of international trade. With the participation of banks in international settlement, the letter of credit settlement method was gradually formed. Letter of credit settlement method after repeated practice problems still exist, has not been well resolved.
First, the people who generate the fraud are lucrative. Since fraud is very lucrative, there are many people willing to take the risk.
Second, the fraudulent people are too poorly aware of prevention, and the ability to counter fraud is not very strong. In terms of fraudulent banks, banks in general in order to reduce the degree of risk will be insured, once the letter of credit fraud, the issuing bank to bear the compensation will also have insurance companies to give compensation, so banks will not have a great incentive to counter letter of credit fraud.
Third, some enterprises engaged in import and export business in China lack professional knowledge, the bank is not obliged to review the letter of credit documentary documents.
In addition, the international trade management order is chaotic, the rapid development of high-tech applications in the forgery, etc. are the reasons for the high incidence of letter of credit fraud.
Risks faced by letters of credit
1. Economic or political risks from the importing country.
International trade is much more complex than domestic trade, changes in the foreign trade policy of the importing country will have a great impact on international trade, even if the exporter submitted a qualified document, the issuing bank also made a commitment to pay, then if the importing country encountered an economic crisis, or political unrest, the issuing bank can not pay on time, these will affect the development of China’s export trade.
2. The risk from the issuing bank.
After the letter of credit is opened, the issuing bank assumes the first responsibility for payment, so the creditworthiness and payment ability of the issuing bank is a key issue. Among the large number of banks in the world, not every bank can issue letters of credit with confidence. If the issuing bank is out of business, bankrupt, etc., it will not be able to receive the payment on time.
3. Risk from the importer.
(1) The importer does not open the letter of credit strictly according to the terms of the contract. The terms of the letter of credit should be strictly in line with the contract, but the importer often does not open the letter of credit in accordance with the terms of the contract for their own benefit, and the letter of credit does not match the terms of the contract, thus making the implementation of the contract difficult or causing the exporter to suffer losses.
(2) The risk caused by letter of credit fraud. Letter of credit fraud is divided into two categories: first, forged documents, including bill of lading, commercial invoice, insurance policy, certificate of origin, quality certificate, commodity inspection certificate, etc.; second, forged letters of credit, or forged or changed conditions of letters of credit.
(3) Risk caused by soft terms. The soft clause in the letter of credit (Soft Clause), also known as PitfallClause in China, refers to the application of the issuer (importer) to open a letter of credit, deliberately set some hidden “trap” clause in order to put the beneficiary in a completely passive situation in the operation of the letter of credit. The issuer or the issuing bank can release the payment responsibility under the letter of credit at any time on the grounds of documentary discrepancies.
4. Risks from the exporter.
(1) Serious non-conformity of the exporter’s delivery. As the letter of credit is an independent document, not bound by the contract of sale, the rights and obligations of the parties to the letter of credit are based on the terms of the letter of credit, if the exporter is substandard, counterfeit the truth, as long as the documents provided by the exporter and the letter of credit match, the exporter can still get the payment, and the importer is victimized.
(2) Exporters forge and alter documents to obtain payment. Exporters can forge the documents required by the letter of credit, such as insurance policies, or pre-borrowing, reverse bill of lading or issue a letter of guarantee in exchange for a clean bill of lading, so that the surface of the letter of credit requirements, fraudulent payment.
Prevent the risk of letters of credit
1. Good investigation. Before the transaction, both buyers and sellers should do a good credit investigation, and establish the trading partner’s file for future inspection.
2. To do a good credit investigation of the issuing bank, choose a bank with good credit and strength.
3. Establish early warning system. Pay close attention to the changes in the political economy of the importing country, do a good job of political intelligence collection, and keep abreast of the dynamic changes in foreign trade controls and foreign exchange controls in the importing country, so as to take early precautions against possible risks and maximize the risk of avoiding the collection of foreign exchange.
4. Risk prevention measures for exporters. After receiving the letter of credit from the notifying bank, the exporter should carefully review it to find out whether there are any discrepancies with the contract or “soft terms”. Once found, you should immediately notify the other party to change the contract and try to choose the terms in your favor. Once the document for the issuing bank refuses to accept or pay, the exporter should immediately take the following measures to reduce losses.
(1) study the reasons for refusal to pay and discuss countermeasures with correspondent banks exporters and importers.
(2) directly with the importer or its agent.
(3) In the export payment has not been paid, the exporter of goods and documents shall bear the responsibility of the final settlement, for this reason, the exporter should pay attention to the handling of shipping documents and preservation of goods. Preventive measures should be the identity of the point and the subject point to the principle.
5. Importer’s risk prevention measures. The importer should put forward clear and specific requirements for bills of lading, insurance policies, commercial invoices, quality inspection certificates, etc. according to the specific requirements of the contract to prevent the exporter from submitting documents against loopholes that do not conform to the contract but conform to the letter of credit.
The importer should fully understand the relevant international practices and domestic and foreign laws, and adhere to the law and international practices.
Require an independent third party to inspect the goods and issue an inspection certificate to ensure that there is no fraudulent phenomenon.
Choose FOB trade terms for transactions, or make liner shipping CFR and CIF, because some documents provided by exporters under these trade terms need to be issued by a more impartial third party, which is less likely to be involved in fraud.
6. Strengthen the training of enterprise practitioners and improve the professionalism of staff.
In conclusion, letter of credit, as the main way of international settlement, provides greater security to both import and export parties. However, in the specific letter of credit operation business, it is important to be aware of the possible risks of letters of credit, enhance the awareness of risk prevention and focus on prevention to ensure the smooth operation of the business and avoid unnecessary losses.