If I pay for undercarriage parts for excavators with a Letter of Credit (L/C), what is the process and cost?

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Paying with a Letter of Credit (L/C) ¹ provides a structured payment system that protects both parties in an international trade transaction. It ensures payment upon compliance with set terms through a bank's guarantee.

The L/C process involves a sales agreement, application, issuance, shipment, document presentation ², bank review, payment, and document collection for the buyer. Costs and fees are higher than typical transfers.

What are the bank fees I will have to pay to open an L/C?

Opening an L/C incurs specific bank fees.

Bank fees to open an L/C typically range from 0.5% to 2% of the invoice amount. For a $50,000 order, expect charges between $250 and $1,000. Amendment, collateral, and discrepancy fees ³ apply additionally.

Breakdown of potential costs

• Issuance Fee: A percentage of the L/C value, charged by your bank (the Issuing Bank) for opening the credit.
• Collateral Cost: Your bank may require you to set aside funds or use your credit line as collateral ⁴, tying up your working capital.
• Amendment Fee: Charged for any modifications made to the L/C after it is issued.
• Discrepancy Fee: Applies if your supplier's documentation doesn't perfectly match the L/C terms, and you agree to waive the errors.

L/C costs

What documents will the supplier need to present to the bank to get paid?

Supplier documentation must meet L/C terms.

The supplier must provide documents like the Bill of Lading ⁵, commercial invoice, packing list, and certificate of origin ⁶ to their bank for payment under an L/C.

Required documentation

• Bill of Lading: Proof of shipment and a document of title for the goods.
• Invoice: Detailed cost breakdown.
• Packing List: Cargo contents, weights, and dimensions.
• Certificate of Origin: Identifies product source.
• Inspection Certificate: (If required by the L/C) Proof that goods were inspected.

Needed documents

How can an L/C protect me as a buyer if the supplier doesn't ship the goods?

An L/C offers security against non-delivery.

An L/C safeguards the buyer by guaranteeing payment only upon presentation of compliant documents ⁷, ensuring goods are shipped before payment is released.

Protection mechanisms

• Payment Assurance: Payment is conditional on the supplier proving they shipped the goods as per the L/C terms.
• Risk Mitigation: If the supplier doesn't ship, they cannot obtain the Bill of Lading and other required documents. No documents, no payment.
• Bank Guarantee: The bank verifies the documents, not just the supplier's claim, before releasing your funds.

Protection aspects

Why are some smaller suppliers hesitant to accept payment by L/C?

Smaller suppliers might shy away from L/Cs due to complexities.

Smaller suppliers may avoid L/Cs due to the complexity, cost of compliance ⁸, and working capital constraints ⁹ tied up until the L/C concludes. They often prefer less formal payments like T/T.

Supplier challenges

• Complexity: L/Cs require strict adherence to terms. A single typo can lead to a "discrepancy" and payment delays.
• Cost: The supplier's bank (Advising Bank) also charges fees for advising, checking, and negotiating the L/C.
• Capital Tie-Up: The process is slower than a direct transfer. The supplier's funds are tied up until after shipment and document processing.

Supplier concerns

Conclusion

Using an L/C to pay for undercarriage parts ensures secure transactions tied to document compliance, albeit with higher associated costs compared to simpler payment methods. Understanding these nuances ensures smooth international trade ¹⁰ operations.

Footnotes  

1. A comprehensive guide explaining what a Letter of