Free Online Course in International BusinessStandby Letter of CreditStandby letters of credit are instruments that stand by to pay if there is non-performance by a party in the transaction. Commercial sellers will accept a standby letter of credit to extend credit and to guarantee payment if the buyer does not pay. It is paid for by the buyer and issued by the buyer's bank against the credit facility the buyer has with his or her bank. It provides the seller with the comfort of collecting against the standby letter of credit should the buyer not pay according to agreed upon payment terms. The seller should never extend more credit in the form of shipments to the buyer than the amount of the standby letter of credit because the seller is only protected up to the amount of the standby letter of credit.Transferable Letter of CreditTransferable letters of credit can be a very valuable financing option but are often misunderstood and improperly executed. The first task is to identify the parties in the transaction. There is an ultimate buyer and an ultimate seller, and between them in the transaction is a broker/sales representative. The broker can represent himself in the transaction or be a distributor for a much larger, well- known company. Using a transferable letter of credit, the broker requires no credit facility or collateral for his role in the transaction, making this action very valuable for the broker. The process works in the following way: A buyer issues a transferable letter of credit to the broker; then the broker transfers to the ultimate seller of the goods the cost of the goods to be shipped. The seller now has the responsibility to make the complete shipment to the ultimate buyer. The broker will never take title to the goods; it passes directly to the ultimate buyer. The seller of the goods is happy because he/she is a party to the letter of credit and is guaranteed payment by the buyer's bank. The buyer is happy because he/she receives the goods under strict compliance of the letter of credit (note that this transaction does not prevent fraud). The broker is required only to replace the seller's invoice with his/her marked-up invoice (the profit) when the seller's documents are presented to the transferring bank; these documents are in turn forwarded to the paying bank with the replaced invoice so that the broker can secure his/her profit in the transaction. This situation appears to be too good to be true. There is, however, risk. The risk is that the ultimate buyer will be able to identify the seller in the transaction and be able to eliminate the broker. This situation can be controlled by carefully structuring the documents in the preparation of the transferable letter of credit and the packaging of the product. When the broker is a distributor, however, it does not matter that the seller is disclosed. For example, take the case of a name brand like Levi's. A buyer knows the maker of the goods but cannot acquire them directly from the manufacturer. The broker is protected by an exclusive distribution contract with the manufacturer (Levi Strauss & Co). The benefits for the broker are now obvious: there is no financing necessary and no need for warehousing a product. The broker has the responsibility for finding a manufacturer for the buyer and preparing an invoice to correspond to the negotiated sale between the ultimate buyer and seller. Transferable letters of credit should not be confused with a back-to-back letter of credit.Export Credit InsuranceUnited States banks do not consider foreign accounts receivable to be eligible for financing, the reason being that the recourse to collect against them is limited and expensive. The United States government as well as other governments throughout the world have realized such and established guarantees to banks in the form of payment insurance to stimulate exports. Ex-Im Bank provides United States banks with a guarantee of payment for specific transactions. Some states have created similar local programs. They often work in conjunction with Ex-Im Bank to provide guarantees to lenders to stimulate their local economies. These programs allow banks to lend against a borrower's inventory and accounts receivable, relying on the Ex-Im Bank or the state program (a domestic source to the bank) to pay in the case of default. This type of guarantee provides insurance of payment. These programs have been recognized by independent insurance carriers as a potential revenue- generating source, enticing them to enter this market and providing competition for Ex-Im Bank. This free market competition keeps rates low for this type of credit facility and provides alternative sources for a borrower. The guarantee allows the banks to fund inventory; it is limited to Ex-Im Bank and is considered pre-shipment financing. The funding of post- shipment financing is provided by both Ex-Im Bank and private insurance carriers in the form of guarantees to a seller's bank against accounts receivables.The range of risk varies from one credit insurance agency to another, but here are examples of some risks covered on a standard basis: 1. Commercial risks only a. company insolvency, including both compulsory and voluntary liquidations b. individual insolvency (bankruptcy) c. protracted default (slow pay) d. receivership e. the appointment of an administrator. 2. Commercial Risks and Political Risks a. commercial risks including the insolvency of a customer and any default on payment (See above) b. financial losses resulting directly from political events, economic difficulties, legislative or administrative measures occurring in a country covered for these risks which prevent or delay the transfer of the sums paid by a buyer or its guarantor (transfer risk) c. risks of a military or a civil war, a revolution, riot or insurrection d. general moratorium decreed by the government of a buyer's country or by any third country covered for these risks through which payment must be made 3. Political Risks Onlya. when the client is worried only about non-commercial issues
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