Letters of credit (L/C) are a traditional financing and risk management tool often used in cross border trade. As a primer on them, my colleague David Gustin writes in a recently published paper, “On-Demand, Event Triggered Finance With Network Models – A Game Changer?,” that “when suppliers don’t offer open terms, traditional trade finance payment instruments like letters of credit (L/C) are typically used, especially in international trade.”
In practice, letters of credit can be complicated (and the paperwork involved is a potential nightmare – which explains why those that automate traditional trade processes like Bolero are in increasing demand. David notes here that:
“Buyers need a credit line to issue a L/C, and while risk mitigation can be a plus for the seller or exporter (if the seller complies with the terms of the commercial L/C) it’s still paper and credit intensive. Yet more and more trade is now done on open account terms. This is good for the buyer, but creates significant collection risk for the supplier. Collection can be particularly difficult when an overseas buyer defaults on payment.”
Technology can change the basis of how we approach cross-border financing. Here, David observes, “The beauty of post-shipment network-based models using approved invoices is that it significantly reduces expense and risk for both parties as well as the third party financing firms who wish to offer intermediated supply chain financing to the B2B relationship.”
Further, “It is not just about lower interest rates, but also the ease of access to capital. No lines of credit, loan covenants, or asset pledging are needed for a supplier to gain access to finance…”
David explores this topic further in his recent paper on the topic (download it here). We also encourage you to investigate our deep, subscription coverage of trade financing, invoicing discount and P2P on Spend Matters PRO.
In addition to Spend Matters PRO research, David and Jason offer workshops, lectures and advisory services to corporations, banks, private funds, consultancies and technology providers that want to learn more about the trade financing ecosystem and its intersections with new technology products and platforms. Contact them directly to learn more: jbusch (at) spendmatters (dot) com or dgustin (at) tradefinancingmatters (dot) com.