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Letter of credit business: definition & important aspects for buyers
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Letter of credit business in a nutshell:
A letter of credit is an irrevocable promise of payment by a bank, whereby the bank undertakes to pay the agreed purchase price to the seller on presentation of certain documents. For the buyer, it offers maximum payment security for international transactions and minimizes risks, as payment is only made once the correct documents have been presented.
Example: A German company imports machinery worth EUR 250,000 from China and opens a letter of credit via its house bank that guarantees payment to the Chinese supplier within 30 days of presentation of the agreed shipping documents.
Contents
What is a letter of credit transaction?
A letter of credit is an internationally recognized instrument for securing payments and deliveries in foreign trade. The importer's bank (issuing bank) promises to make a payment to the exporter (beneficiary) as soon as the exporter presents the documents specified in the letter of credit. This procedure minimizes risks such as non-payment or non-delivery and creates trust between business partners who may not know each other personally.
Core elements of the letter of credit business
Significance for purchasing
In the procurement process of international companies, the letter of credit business plays a decisive role in securing supply chains and payment flows. It enables buyers to source goods from unknown or new suppliers without taking the full risk of prepayment. By involving banks, trust is strengthened, facilitating market entry into new countries and supporting global sourcing strategies.
Letter of credit business: from traditional documents to digital solutions
Building on the theoretical basis of the documentary credit business, this instrument continues to be an essential component of international trade. In practice, the letter of credit provides security and trust between buyers and sellers, especially in cross-border transactions. However, traditional processes often lead to delays and increased administrative effort. Advancing digitalization has therefore highlighted the need for more efficient solutions to make trade faster and more secure.
Old: Classic documentary letter of credit
Traditional approach: With traditional documentary letters of credit, orders are processed using physical paper documents. After shipping the goods, the seller submits the required documents such as commercial invoices, bills of lading and proof of insurance to their bank. These documents are checked manually and forwarded to the buyer via correspondent banks. The entire process is time-consuming and prone to errors. Typical challenges include postal delays, loss of documents and inconsistencies in paperwork that can lead to non-payment or risk management.
New: Electronic letter of credit
Electronic Letters of Credit: Modern approaches use digital platforms to process documentary credit transactions. Switching to electronic documents and digital signatures speeds up the process considerably. Documents are exchanged in real time over secure networks and automated systems check compliance with the terms of the letter of credit. These innovations reduce the risk of errors and eliminate delays caused by the physical transfer of documents. They also increase the supply chain visibility and traceability of every transaction, boosting the confidence of all parties involved.
Practical example: Digitalization at TradeSecure GmbH
TradeSecure GmbH, a German import-export company, implemented an electronic letter of credit system to optimize its international trade. Following the introduction of the digital solution, the processing time per transaction was reduced from an average of ten days to two days. The electronic verification of documents led to a 70% reduction in errors. Communication costs were also reduced by 40%. These efficiency gains enabled TradeSecure GmbH to increase its turnover by 15% within a year and open up new markets in Asia and Africa.
Conclusion on the letter of credit business
The letter of credit business is an indispensable instrument in international trade that offers decisive advantages despite higher costs and administrative effort. It minimizes risks for all parties involved, creates trust between unknown trading partners and enables secure global business relationships. With increasing digitalization, the letter of credit business is becoming more efficient and user-friendly, but its basic function as a hedging instrument remains important for international trade.
