No Letters of Credit (L/C) means No Shipping

Of the $13.6 trillion of goods traded worldwide, 90 percent rely on letters of credit or related forms of financing and guarantees such as trade credit insurance, according to the Geneva-based World Trade Organization.

Letters of credit are centuries-old instruments that allow far-flung partners to complete large transactions. An importing company gets its bank to issue the letter, guaranteeing payment for a delivery. That bank provides the letter to the exporter’s bank, which then guarantees payment to the exporting company.

The system breaks down when banks don’t trust one another and are unwilling to accept a letter of credit as proof that payment is coming.

From 2000 through last year, the use of letters of credit declined to about 10 percent of global trade transactions, the IFC’s Stevenson said. Over the past six months, they began “roaring back into fashion” as sellers sought to guarantee payments from buyers they no longer trusted, he said. At the same time, liquidity problems caused banks to increase charges.

Rates Rise

The cost of a letter of credit has tripled for buyers in China and Turkey and doubled for Pakistan, Argentina and Bangladesh, said Uwe Noll, director of country risk sales at Deutsche Bank AG. Banks are now charging 1.5 percent of the value of the transaction for credit guarantees for some Chinese transactions, bankers say.

“The whole global trade production line relies on letters of credit,” Matt Robinson, an analyst at Moody’s Economy.com wrote in an Oct. 23 report. “No letters of credit, no transactions — and no transactions mean no international trade.”

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