Letter of credit is operated by business world based on the guidelines of uniform customs and practice of documentary credit under notification 600 adopted on July 1, 2007 with a modification of UCP 500 followed previously.
Are there any demerits in operating an LC? If letter of credit has disadvantages to buyers, what are they? Let us discuss from the side of importers on demerits of LC.
One of the major disadvantages of letter of credit is that LC is operated on the basis of documentation and not on the basis of physical verification of goods on its quality, quantity or other parameters. In other words, an LC issuing bank can effect payment to beneficiary of LC on the basis of documentation produced as per the terms and conditions of letter of credit. The parties under letter of credit do not have any right to physically verify the contents of goods. So, if the buyer needs to confirm and satisfy on the quality of goods he buys, he can appoint an inspection agency of international repute and instruct exporter to enclose certificate of such inspection by mentioning a condition in letter of credit.
Once opened a confirmed and irrevocable letter of credit, the importer/buyer already tied up with the said business credit line and can not change in between. Due to various reasons, especially on selling price variation, if buyer needs to stop his export order he can not do so.
Compared to other payment mode of transactions, cost of operating letter of credit procedures and formalities are more, which may be an additional expenses to an importer especially on amendment, negotiation etc.
Currency fluctuation is another disadvantage of Letter of credit. Normally buyer/importer places purchase orders once in a year and opens letter of credit accordingly. The exchange rate may differ at the time of effecting payment. So, if any loss due to fluctuations in foreign currency contracted under letter of credit, need to be beard by him. This is also one of the major demerits of LC.
Currency fluctuations may also effect on price variation in local market. The demand of imported goods may reduce due to such fluctuation of foreign currency. So currency fluctuation also is a threat under letter of credit which is treated as other disadvantages of letter of credit.
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