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The Good And Bad About Letters Of Credit
Here we will show you some the positive and negative aspects 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.
If the importing country changes its currency rules in the course of a transaction, it is likely that the government will allow that LC outstanding and are satisfied, for fear of launching their national banks (local) in an international disdain for a job if this LC confirmed by a bank in the country of the exporter.
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 also present difficulties to the importers:
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.
Exposure to movements in the exchange rate: Fluctuations in exchange rates may affect the demand of the product of a foreign company, when the currency strengthens national product denominated in that currency become more expensive for foreign customers, which may cause a decrease in demand and therefore a decline in inflows of cash.
Corporations working abroad are also vulnerable to the economies of the countries to which they export their goods. Corporations need to do their own research before entering a new market because LC may not protect them from negative economic dynamics.
LC would provide some stability but provide little guarantees when it comes to political and economic decisions of foreign governments.
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