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International Credit Risk

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Additional Terms
Under the International Chamber of Commerce’s Uniform Customs and Practice for Documentary Credits (UCP 600) rules, L/Cs are irrevocable; they cannot be canceled or modified by the issuer without the consent of all parties. However, an importer can request a revocable L/C from the bank, which enables the issuer to modify terms without consent of the seller. To ensure an agreement is binding, exporters should require an irrevocable L/C subject to UCP 600.

Exporters can further reduce risk by requesting a confirmed L/C, particularly when trading with countries subject to political upheaval, foreign currency shortages, unfavorable exchange regulations, and economic collapse. The importer’s bank authorizes a U.S. bank to add its guarantee should the issuing bank be unable to pay. Use of an unconfirmed L/C exposes the exporter to all these risks.

Letters of credit can be structured to pay upon presentation of documents and verification the seller has complied with the terms, called a ‘sight’ L/C; alternatively, a ‘time’ or ‘usance’ L/C provides a grace period. Once documents are presented and verified, payment is made on a specified future date.

When dealing with multiple purchases over a period of time, an exporter may request a revolving L/C. It eliminates the need to issue a new L/C for each purchase. The issuing bank guarantees the amount of credit will be available again, usually under the same terms.

A bank may also recommend other types of L/Cs, such as when an exporter is unable to pay suppliers before receiving an importer’s payment. In this case, the exporter’s bank issues a back-to-back L/C in favor of the supplier. The strength of the L/C is based on the guarantee of payment from the importer’s bank.

Letters of credit can also serve as performance bonds, since many parties play a role in getting produce from point A to point B in international trade. A standby L/C in favor of an importer guarantees the exporter will meet its contractual obligations to pay third parties involved in the deal.

Credit Insurance
The increasing desire for open account terms has spurred growth in trade credit insurance. Purchased by the exporter, credit insurance covers nonpayment due to factors such as insolvency, political risk, and exchange rate fluctuations.

“Credit insurance eliminates the need for a letter of credit, which ties up the buyer’s credit,” explains Ben Clumeck, West Coast regional manager at Atradius Trade Credit Insurance.

Based on an extensive analysis, the insurer will advise an exporter on the amount of credit that should be offered to a specific buyer. Atradius monitors companies in more than 120 countries. “If we can’t cover a buyer, we tell our clients to sell on cash-in-advance terms only,” said Clumeck.

Policies can be structured based on a portfolio of accounts or only the largest buyers (key accounts). Premiums are based on country risk, business volume, loss history, and a risk analysis of an exporter’s buyer mix. “One of the biggest misconceptions is that insurance is expensive,” Clumeck commented. “Cost generally runs 0.10 percent on the insurable sale to 0.5 percent. For high risk or low volume, it could go to 0.75 percent.” Policies typically cover up to 90 percent of a contract’s value. Claims for nonpayment are usually paid within 15 days of nonpayment, according to Clumeck.

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