Disadvantages of Letter of Credit to importers in Global Trade

What is a Letter of Credit?

A Letter of Credit is basically a guaranteed document that is issued by the Bank to a company or institution (Buyer) and it ensures that this buyer will pay to the seller on time and for the correct amount of goods and services ordered. But in case of default or if the buyer unables to pay the amount, then the Bank will compensate the seller on the behalf of issuing a letter.

Global financial trade most of the time relies on Letter of Credit to avoid payment failure while maintaining everything in the import and export sector. It is a highly customizable and effective form that can reduce credit risks. But on the other side, there are also some demerits in Letter of Credit which I would like to discuss with you.

Demerits of Letter of Credits

Well, the Letter of Credit operates on the basis of documents verification rather than physical assessment and there may be a number of factors such as quality and quantity, and other factors. Keeping in view this condition, the beneficiary of LC has to produce documents according to the terms and conditions of Letter of Credit and everything is attached with LC issuing authority(Bank).

There is another inescapable disadvantage that is nothing but cost and formalities especially amendment and negotiation, which are borne by the importer and this process definitely increases burden as compared to other modes of payment or transactions.

Fluctuation in exchange rates is another demerit of Letter of Credit. If any change occurs in currency, especially at the time of payment, which is far different from the original cost, then all the additional charges are borne by the importer.

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