The Link Between Incoterms 2000 and Letter of Credit Documentation Requirement and Payment Risk
Abstract
Letters of credit are an important finance instrument for international trade. These instruments are particularly useful in trade where the transactional values and trading risks are high. Essentially the letter of credit is a substitute for a buyer’s risk with that of his bank, as it underwrites the transaction. Exporters experience difficulties in achieving documentary compliance to the bank’s satisfaction and therefore run the risk of not being paid. Compliance is based on the accuracy and form of data content on documents required by the letter of credit. The more voluminous and complex the documentary requirements, the higher the non-compliance risk. This paper explores the link between international delivery terms and documentary requirements of the letter of credit. Preliminary data from an industry survey suggests that exporters are contracting on international delivery terms that may leave them unnecessarily exposed to non-payment risks. Although further investigation is required to determine whether alternate delivery terms would diminish the exporter’s risk, preliminary results indicate that it is possible to reduce payment risk by the strategic use of international delivery terms.
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