Is the Letter of Credit Waning?

e-invoicing

I’m married to a former metals trader, who at one point in her career collateralized her own trades. (There’s nothing like managing your own trading book of business with your nest egg at stake!) Back then the letter of credit was standard practice across the vast majority of trading and procurement activity, and she spent hours each day working on paperwork to satisfy bankers and counterparties.

But where is the letter of credit today? I’ve seen different sources of data suggest that trading activities involving the letter of credit are alive and well, despite a trend to open account trade. But others suggest both anecdotally and from third-party research that the L/C is on the wane.

There’s probably some truth to both sides of the argument, depending on how one defines the question. For example, are we counting absolute number of transactions, overall volume, new buyers or sellers, different or specific geographies or something else?

Still, a Barclays banker makes a great case in this TFX News article that L/C use is declining as non-recourse receivables finance growth accelerates. As he observes with open account trade, there has been a “dramatic shift from traditional trade instruments, such as import L/Cs, advanced payments or collections to open account terms with counterparties in recent years with close to 90% of all global trade transactions now being on an open account basis.”

Further, the growth of non-recourse financing programs is also contributing to the trend. For example, a survey conducted of Barclays clients found that “67% of corporates are seeing an increase in open-account trade and 35% of the companies showed that they were already running a receivables-financing program or were considering doing so in the near future.”

In part, this increase “is being driven by a rise in open-account trade, especially from suppliers in the development world, pushed by the major retailers/importers in the developed world, including the acceptance of factoring as a suitable alternative to traditional forms of trade finance.”

So where do observations and survey data like this leave the future of the humble L/C? I would argue the rumors of its death have been greatly exaggerated, thanks in part to technology automation.

Just as we have seen investments in accounts payable automation and e-invoicing speed up the approvals process to create a greater window to finance payables – and to create greater visibility financing an increasing number of transactions from both internal company balance sheets as well as third party-sources of capital – so too can related systems and online frameworks make the letter of credit a more efficient tool. All while keeping the protections it provides to parties – the main reason it originated in the first place!

Want more clarity on how e-invoicing and supplier networks fit into the overall accounts payable (A/P), procurement, purchase-to-pay (P2P), treasury, and supplier and risk management equations? Download Jason Busch’s research paper, Understanding How E-Invoicing Fits, to answer the market’s most frequently asked questions about this vital topic.  

Related Articles

First Voice

  1. Neville Calvert:

    Jason,
    A great obsveration. I love L/C’s more than I do just about any other receivable financing instrument. L/C’s offer both parties to a transaction more opportunity and security now than ever before. The L/C is a much maligned instrument. Open account trading has developed as the lazy way to ‘sell’ it is hardly ‘trading’. The development and expansion of technology platforms today, such as that provided by Bolero, afford traders and the financiers thereof a far more secure and timely trading environment. Compare the simple ability to achieve back-to-back funding of a confirmed L/C to the effort required to flog an unconfirmed open account PO to the market. L/C’s are not just for developing or currency controlled countries. Nor are they restricted to large commodity (resources, agri) trades. They can be applied effectively to any trade. The felixility of the L/C enables great structuring options through the value chain. You can do some pretty wild trades with L/C’s that you simply could not do on open account! Education of treasurers in the application of L/C’s is worth the effort. An instrument well worth reviving if it is not in the arsenal. Long live the mighty L/C!

Discuss this:

Your email address will not be published. Required fields are marked *