Skip Navigation
Letters of Credit and How They’re Used
June 22, 2021 Ken Click, Business Development Specialist & Mark Klein, Managing Director, Lender Accounts

Every U.S. company expects to get paid on an international sale and there are a variety of payment instruments available. Each payment instrument, however, carries varying degrees of risk to the seller as well as the buyer. One example is letters of credit, a payment that is considered slightly less secure to exporters as cash in advance. Letters of credit shift the payment risk and responsibility to the foreign buyer’s lender. It’s a legal contract valid for a limited timeframe, such as 90 days, and the fees to create one are typically paid for by the foreign buyer and exporter. There are two types: sight letters of credit and usance/deferred letters of credit.

Sales Terms as a Spectrum of Risk
Sales terms as a spectrum of risk; trade terms include open account, cash against documents & other documentary collections, usance/deferred letters of credit, sight letters of credit, and payment in advance.  Open account terms offer the highest risk to the seller and lowest risk to the buyer, while payment in advance offers the lowest risk to the seller and highest risk to the buyer.

A sight letter of credit is the most common type of letter of credit. It facilitates payment from the foreign buyer through their bank (issuing lender) to the U.S. exporter through their bank (negotiating lender). The exporter presents transactional documents (e.g., commercial invoice, ocean bill of lading, certificate of origin, etc.) to the negotiating lender and then gets paid when the documents are deemed compliant with the letter of credit. The required documents are specifically addressed within the letter of credit language.

A usance/deferred letter of credit is similar but involves a term which gives the foreign buyer more time to pay (e.g., when an exporter submits its compliance documents to the issuing lender, the issuing lender will remit payment within a specified period such as 60 or 90 days). The longer period gives the foreign buyer more flexibility to manage its cash flow and capital expenditures. This payment instrument is commonly seen in the agricultural industry which has long issuance periods.

An alternative to letters of credit is Export Credit Insurance from EXIM. This product enables exporters to sell on open account terms (generally up to 180 days) and therefore be more competitive by offering their foreign buyers payment flexibility. Meanwhile, exporters are also protected against foreign buyer nonpayment due to commercial and political risks and can bypass the lender fees associated with obtaining letters of credit. To learn more, please contact an EXIM trade finance specialist for a free consultation.

Get a Free Export Finance Consultation Today!

EXIM’s Blog postings are intended to highlight various facets of exporting, but the postings are not legal advice, and are not intended to summarize all legal requirements associated with exporting.