Deferred payment letter of credit is a well known phrase in the arena of international business transactions.
24
September
2011
Stacy B Miller's picture

Deferred payment letter of credit is a well known phrase in the arena of international business transactions. Oftentimes, several issues like distance, varying import laws, their different procedures and improper communication can disrupt an international negotiation procedure. In fact, if the buyer and seller are not familiar with each other and have not got enough time to form a working relationship; their deal can get canceled due to trust issues. Nevertheless, a deferred payment letter of credit can sort these problems out quite easily.

What is deferred payment letter?

The deferred payment structure is one of the most common sales and marketing tools which are used by many renowned companies. The entire concept of deferred payments is based on debts that are created today but are not due for payment until some agreed upon date in the future.

Significance

In global transactions, when the buyer and seller agree on prices and terms, the buyer generally seeks assurance that he is going to receive his products and the seller look for a guarantee that he is going to receive his money. A letter of credit handles both these issues perfectly, by incorporating the international banking system into the process. At first, the buyer’s bank opens a letter of credit in favor of the seller, the beneficiary which involves the credit standing of the bank in the place of the buyer. In the next step the issuing bank sends forth the letter of credit to another bank, the negotiating bank, in the seller's country. Now, it’s up to the negotiating bank to add its confirmation or guarantee to the letter of credit, provided the seller has requested for it.

Negotiation

As soon as the seller ships the merchandise, his freight forwarder prepares the requested documentation on the basis of the letter of credit and presents these documents to the negotiating bank. After going through the documents thoroughly, if the negotiating bank figures out that the documents are authentic and accurate, they accept the documents for payment and further send them to the opening bank of the letter of credit.

Payment

As the name suggests, the payment through the letter of credit can be delayed or deferred for a period of 30 to 180 days from the date of acceptance. The exporter can hold the accepted draft for a stipulated period of time and then can present the draft to the bank for payment or he can simply request the bank for discount the draft and pay him the net proceeds. An active market is out there for discounting the accepted drafts. The interest rates offered here are quite low because they carry a bank guarantee of payment. Once the exporters decide to accept a deferred payment letter of credit, he has to include the interest cost of discounting the accepted draft into the pricing of his products.

Benefits

A deferred payment letter of credit offers several benefits. It allows the buyer to import at a considerably lower interest rate. If the buyer would go to his local bank to borrow the money to finance his purchase and inventory, he would have been charged a much higher rate of interest there. Moreover, the exporter attains a competitive advantage by agreeing to accept a deferred payment letter of credit. After all, he is signing the agreement to provide financing terms to the buyer at a much lower cost.

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