Finance Using Incoming Letters of Credit

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Funding against an incoming letter of credit can be trickier than it ought to be in today's banking environment. A documentary letter of credit (DLC) can only be cashed upon presentation of the required shipping documents and inspection reports (if needed). 

BEFORE THE GOODS SHIP, THE DLC HAS POTENTIAL VALUE, BUT IT ISN'T FUNDABLE OR CASHABLE YET. YOUR SUPPLIER WANTS TO BE PAID IN ORDER TO PRODUCE AND SHIP, BUT YOU WON'T BE ABLE TO CONVERT THAT DLC INTO CASH UNTIL YOUR SUPPLIER SHIPS THE PRODUCT. IF YOU HAVE RECEIVED A NON-TRANSFERABLE LETTER OF CREDIT IN PAYMENT, YOU ARE GOING TO NEED A BRIDGING MECHANISM TO PAY YOUR SUPPLIER TO GET YOUR DEAL ALL THE WAY HOME. MANY TRADERS LOOK FOR EITHER A BACK TO BACK LETTER OF CREDIT OR A TRANSFERABLE LETTER OF CREDIT AS A WAY OF UTILIZING THE INCOMING DLCTO PAY THE SUPPLIER. IN BOTH CASES, THERE CAN BE ISSUES.

A transferable letter of credit may reveal the identity of the buyer to the seller, and vice versa. For the trader in the middle, this factor may blow the whole deal especially if a consistent series of transactions between the two is expected. A back to back letter of credit poses a different problem. In this case, two different banks are likely to need to handle the documents, increasing the time needed to clear and the increased possibility of snags from one of the banks if everything isn't perfect.

The simplest way to handle matters is with an authenticated payment instrument issued to the supplier by your designated receiving bank, based on supplier's submission of required shipping documents. This is exactly the same process that supplier would follow if you sent him a letter of credit. When you use an assignment of the proceeds from the letter of credit, you bypass duplicate sets of documents and streamline the process, with a lot more control over the transaction.