A broad spectrum of business community in Bangladesh are familiar with 'letter of credit' but many are not aware of the nuances, complexities and, most importantly, the hidden risks of doing business through this system of settling cross border payments. Lack of awareness, especially among the newcomers, has seen the undoing of many exporters leading to broken dreams and failed businesses. The strings of closed-down factories dotting the country's landscape attest to the perils of exporting merchandise without identifying the potential risks associated with it.
There are many - some legal, some academic and a few scholarly - definitions of a letter of credit, which is often abbreviated as LC. Simply stated, an LC is a guarantee of payment from a bank to some one who would be supplying goods and services to the bank's named customer. What, in effect, this guarantee means is that it joins with the buyer to assume the obligation to pay the supplier for the underlying goods or services. Beyond this simplistic definition, there are number of conditions and question marks that need to be answered before you get a full measure of what it takes to safely navigate the rough terrain of a letter of credit.
No exporter should entertain any illusion that he would automatically receive payments for the supplies he makes against an LC. The search for safety should logically start with evaluation of the creditability of the bank that opens the letter of credit, known in the banking parlance as the LC-issuing bank. Banks are universally believed to be trustworthy and are not ordinarily expected to renege on their commitments. They are closely supervised by the central bank or one or more agencies of the government. Unfortunately, the banks in some countries are not strictly mindful of their obligations nor are their regulatory authorities strict enough in enforcing financial discipline. With the exception of a few, a sprinkling of the unreliable banks could be found across the continents of Africa and Latin America or even newly-independent countries in Eastern Europe, otherwise known as Commonwealth of Independent Countries (CIS). Some of them are also reportedly have found their way to London and other western capitals to spruce up their reputation and credibility but remain as unpredictable as they are in the home bases.
When you receive an order for export against a letter of credit opened by a little known bank, make sure to ask the buyer to get it confirmed by a reputed bank, preferably in Europe or North America. If the buyer is not willing to arrange the confirmation, a better option would be to ask for payment in advance if you have strong doubts about the credibility of the buyer and the LC-issuing bank. It may at times scare away the buyer but that would, nonetheless, be preferable to lamenting over the lost money after the curtain is finally drawn on the ill-fated deal.
It is not always that the LC-opening bank would be the only problem. Some Third World countries maintain rigid exchange control with bizarre rules for securing central bank's approval for remittance against an import especially when foreign exchange reserve tends to dry up. The bureaucratic red tape to collect that approval by your buyer could keep you waiting for an eternity to retrieve the export proceeds. Political instability due to coup or insurgency in many countries should also be read as a red signal when an order is received from them. With all those financial crises bedeviling Greece and other European countries that brought them close to bankruptcy, it would be wise to get an update on their financial health too before you make a shipment.
So the second step in your search for safety would be to get a sense of the financial health and legal environment of the country to which you are going to make a supply. In this age of information technology it is quite easy for you or your banker to quickly collect the dossiers on the buyer, the LC-issuing bank and destination country itself. Web sites would be a primary source and may, if needed, be supplemented by reference made by your bank to its overseas correspondents. If the order is big enough, investigation through a credit rating agency, though a little costly, would be worthwhile.
When you receive an order to export, backed by an LC, please don't jump on cloud nine at the prospect of harvesting the as yet unseen rewards. When you are finished with the initial euphoria, calm your nerves and quietly sit down to examine the terms and conditions incorporated in the export order and the LC to find out what your obligations would be to execute the order. In their rush for executing the orders many exporters accept very difficult terms that cannot be realistically fulfilled but they hope, nevertheless, that it would somehow be possible to beat the odds. It explains why we have so many failed businesses, especially garment units, who neglected to spot the pitfalls that lay ahead to fulfill the export orders. When you have an order with or without cover of an LC from a buyer, the following are some of the important questions that you need to ask yourself:
* With all these labour unrests exacerbated by hartals, violence, arson and lockouts, in addition to the congestion at the port, would I be able to maintain the shipment schedule stipulated in the LC?
* Are the stipulations concerning freight payments, bank charges and other costs acceptable? Your failure to sort out these issues beforehand may see your expectation of profit dashed by the costs as they unfold in course of your preparation for executing the order.
* Is the price adequate to take care of the escalating cost in the backdrop of the country's inflationary environment and possible adverse movement of exchange rates?
* Is the description of product either insufficient or too detailed? Do not overlook the possibility that your infrastructure may not be suitable to produce the kind of material described in the LC.
* Are the stipulated documents difficult or impossible to obtain within the limited time frame?
If you think that it will be difficult to fulfil any of these terms, you should not hesitate to renegotiate the terms with the buyer followed by an amendment of the LC. If you start the production process in the hope of doing it at leisure you will find yourself in the wrong end of the deal with a heavy load of 'stock lots', rejected consignments at your end or off-loaded cargo incurring port charges and demurrages in foreign ports.
When you send a consignment that does not comply with the LC terms, the buyers abroad, especially the unscrupulous ones, would once again seize the opportunity to exploit your vulnerability to squeeze heavy discounts.
Strange as it may sound, about half of all the documents presented to the banks by the exporters contain discrepancies. The following are the common ones:
* The validity of the Letter of Credit expired before presentation of the export documents to the negotiating bank.
* Bill of Lading evidenced delivery either before opening of the LC or after the last date of shipment mentioned in the credit.
* After the shipment the documents are not presented to the negotiating bank within the time mentioned in the LC.
* The descriptions of merchandise regarding the quantity, volume, quality etc. differ from one another. It must be noted that a slight variation in the description may lead to rejection of the documents even if the merchandise is fully responsive to that ordered for. Often times, these types of minor discrepancies too can be used by buyers as a pretext for claiming heavy discounts.
* Ports of loading and destination are different from those specified in the credit.
* One or more documents required by the credit are not presented.
* Invoice and other documents are not signed as stipulated in the letter of credit.
When one or more of these discrepancies are detected by the negotiating bank, it will neither negotiate the documents nor purchase or discount the draft.
So your final search for safety would concentrate on assembling the stipulated documents quickly enough for presentation to the bank well before the deadline. If a discrepancy is detected by the bank, make the necessary corrections quickly. Some discrepancies like date of shipment or the quantity shipped, however, cannot be corrected. In that event, the best option is to ask the bank to bring the discrepancies to the notice of the LC-issuing bank for waiving the discrepancy with the consent of the buyer and request an authority to pay to the exporter. For minor discrepancies, however, the negotiating bank may purchase the bill against an indemnity from the exporter that he will refund the money if the LC-issuing bank/importer refuses to accept the discrepant documents. The banks call it as 'negotiation under reserve'. In the event a negative response is received, the exporter is left with the painful task of searching an alternate buyer to sell the goods, often at a vastly reduced price.
The writer is a former Executive Director of Bangladesh Bank.
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