When working about overseas, you may hear the term L/C when signing a contract. This is a commonly used payment method, so you should know about it if you are doing business overseas.
L/C is an abbreviation for Letter of Credit and means letter of credit in Japanese.
As you can imagine from the name, the purpose of a letter of credit is to make mutually reliable payments between a seller (exporter) and a buyer (importer).
So, what is a reliable payment method?
L/C is the establishment of terms for delivery of goods and payment between seller and buyer.
By using L/C settlement, it is possible to prevent the buyer from being unable to obtain the product from the seller despite paying in advance, or conversely, preventing the seller from defaulting on payment after delivering the product to the buyer under deferred payment terms. can do.
L/Cs involve not only buyers and sellers but also banks to settle payments, ensuring non-payment and delivery of goods. .
Basically, the buyer’s bank issues an L/C to the seller, and the seller presents documents based on the terms of the letter of credit, allowing the bank to pay for the product on the buyer’s behalf.
It is a very complicated process, so once a relationship of trust has been established between the seller and buyer, it may be possible to change to T/T payment (Telegraphic Transfer Remittance).
The following is the general flow of L/C settlement. (Created with Chat GPT)
- Transaction Agreement: A buyer and seller agree on the terms of a transaction, such as the product or service, price, and terms.
- Application for issuance of L/C: The buyer applies to the bank to issue L/C. An L/C is a guarantee of payment to the seller, in which the bank promises to make payment to the seller on behalf of the buyer.
- Issuance of L/C: Buyer’s bank issues L/C. At this time, transaction terms, payment schedule, shipping documents, etc. are specified in the L/C.
- Notification of L/C: Seller’s bank receives the L/C and notifies the seller. The seller will proceed with the transaction based on the terms of the L/C.
- Shipment of goods or provision of services: Seller ships goods or provides services based on the terms of the L/C. At the same time, we will prepare shipping documents and related documents.
- Submission of documents: The seller submits the documents specified in the L/C (shipping documents, transport documents, invoices, etc.) to the bank.
- Bank examination: The bank will examine the submitted documents and confirm whether they match the conditions of the L/C. If the conditions are met, the bank will make the payment to the buyer.
- Payment to the buyer: After the bank makes the payment, the buyer takes ownership of the goods or services. The buyer receives documentation corresponding to the amount paid.
- Cancellation of L/C: After the transaction is completed, the L/C will be canceled.
L/C settlement is used to increase the safety and reliability of transactions. Banks guarantee payments, reducing risk for both buyers and sellers.
However, while improving the reliability of transactions, there are also some disadvantages. Let’s list its main disadvantages below. (Created with Chat GPT)
- Fees: Banks charge fees for L/C issuance, notification, examination, payment, etc. This can increase the total cost of the transaction.
- Complicated procedures: L/C transactions are complicated and procedures are complicated. Parties to a transaction must follow certain documents and procedures, and failure to do so can potentially stall the transaction.
- Time-consuming process: L/C procedures are time-consuming. It can take several weeks between document submission and payment, which can prevent a quick transaction.
- Limited Scope: L/Cs are mainly used for international transactions, but less commonly for domestic transactions. Also, some traders tend to avoid L/Cs.
- Lack of flexibility: L/Cs are subject to very strict terms and can be difficult to change or amend. If you need to change the terms during a transaction, the process becomes difficult.
- Fraud risk: If there is fraud, such as forging documents, the bank may miss a flaw in its review. This creates a risk that the payment will be made but the goods or services will not be provided accurately.
- Credibility of the buyer and seller: Before the L/C is issued, the buyer and seller must verify the credibility of the bank. Reliability issues make trading difficult.
Due to these characteristics of L/C settlement, it is an effective method for those dealing with a party for the first time. Banks handle this, so if you have the opportunity, try using L/C payment.