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Letters of credit alive and well as global trade risks increase

Despite much talk in the past of the demise of clunky letters of credit (LCs) in favour of open account trade, the use of commercial LCs is actually growing as a proportion of overall trade finance products. This is according to the ICC's 2015 global survey on trade finance, Rethinking Trade and Finance 2015 - An ICC Private Sector Development Perspective. LCs account for 44.36% in 2015, up from 41% in the 2014 survey.

According to the survey report, instability in some of the leading global trade markets combined with the current perception of increased risk of default for imported goods and services, are behind the increased use of LCs. Importers are therefore more likely to want to fix the amount and currency to be paid, before the goods are actually shipped.

The survey also found that standby LCs make up 7.7% of the mix, which is an increase from 5% in the 2014 survey, while bank guarantees account for 12.71% of overall export trade finance products. Open account or supply chain finance methods make up 14.77% of the total. The report also notes that “respondents to this survey generally originate from traditional trade finance departments and often open account transactions are handled in different departments of their banks.”

It also found that bank guarantees fell to 14.23%, down from 20% in 2014, as part of total import trade finance products. The driving factor behind this decline, says the report, is a decline in sectors that are heavy users of bank guarantees and bonds, such as infrastructure, construction and shipbuilding, particularly caused by the economic slowdown in some major emerging markets.

The report says: “The reported increase in the use of the commercial letter of credit in this 2015 survey may be short-lived, given the progress being made in electronic trade payment platforms, the expansion of factoring, short-term export credit insurance and other supply chain products.”

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