LC’s are seen as a revocable instrument. This can be due to the poor drafting and governing law and clauses added with it. The following points are not covered in letter of credit;
Majority of the trades these days tend to have an international link. According to a report published by The Economic Times, India’s total outward shipments in the financial year 2017-2018 was approximately $303.5 billion. Considering that the World Trade Organization had only recently cut the global trade forecast by 2.6 percent, the $303.5 billion amount is considered to be quite a healthy number. From the perspective of globalization, this is absolutely good news. At the same time, since international trade involves factors that take place outside an importer/exporter’s control, this can be quite a risk affecting letters of credit. These factors include a change in the trade regime, civil war, mass riots, transfer risks, currency control systems and sovereign risks to name a few.
Besides restrictions that occur due to geographical differences, international trade also consists of fraud risks. In comparison to international trade, domestic trade does not represent as high a fraud risk as the former. Further, businesses that involve a bigger transaction also tend to pose a danger in terms of compensating losses quickly. Also, let’s not forget that fraudulent companies disappear before one can reach them legally. Since banks tend to only deal with documents and not goods, services or performance of the buyer or seller’s company, this feature tends to become the major source of fraud risk for the bank.
RISKS FOR APPLICANTS
Applications in this case are considered to be the importer in a commercial letter of credit transaction. There are numerous reasons as to why applicants are subject to facing risks such as risks related to shipments, shortcomings of the issuing bank and fraud-related risks. When we talk about risks related to shipments for applicants, factors such as shorter shipments, late shipments and shipments of low quality goods top the list. Shortcomings of the issuing bank involve factors such as failure to pay the L/C amount. In this case, the applicant may be required to pay the credit amount to the beneficiary, which is an unforeseen circumstance that the applicant may or may not be prepared for. Applicants tend to face fraud-related risks that most commonly stem from the acts of the beneficiaries that float forged documents.
RISKS FOR THE BENEFICIARY
When involving letters of credit, beneficiary is referred to the party in whose favor a credit has been established. Some of the top factors comprising risks for the beneficiary include discrepant document risks, fraud-related risks and non-payment risks. If the bank is able to recognize in time that the documents provided are discrepant, then no party gets adversely affected. However, there are times when banks might take time to figure out the discrepancy involved, which poses a major threat to the beneficiary.
Above mentioned risks are just a few of the many categories of risks involving letters of credit for all parties. Therefore, it is vital that there are no compromises made when it requires one to follow appropriate banking policies and regulations. An overall understanding of one’s business is also essential, so that letters of credit work for you rather than against you.