Merchants and consumers worldwide experience challenges while carrying out business transactions. Significant challenges include delayed delivery, deferred payments, and other financial-related issues. Moreover, multinational trade experiences diverse rules and regulations, distance barriers, and political landscape variations.
A promise of payment is usually brought into play to cushion sellers against risks. The most effective form of payment promise is the letter of credit, which involves a third party – primarily a financial institution like a bank. So, what is letter of credit?
What Is A Letter Of Credit?
But what exactly is letter of credit in the Singaporean context? In Singapore, a letter of credit is a financial tool that a bank or any other financial institution offers, guaranteeing that the seller will receive total and timely payments, primarily when the buyer is otherwise unable to.
Importance in International Trade, Especially in Singapore
In Singapore, the letter of credit has proven pivotal in the sustainability and transformation of the country’s economy. By providing a secure payment mechanism for sellers and buyers, businesses have been able to carry out operations efficiently, contributing to the growth of the Singaporean economy. But is that all? Let’s find out in the article below.
- A letter of credit is a financial instrument to a seller from a bank that guarantees they will receive their payment in full and on time.
- The international trade industry has made it necessary to involve the letter of credit in their transactions.
- There are different letters of credit, including commercial, revolving, traveller, confirmed, and standby letters of credit.
- Not that you’ll incur some cost to obtain the letter of credit from a bank issuing a letter of credit.
How A Letter Of Credit Works In Singapore
Buyers undertaking major purchases in Singapore need a letter of credit from a reputable bank to assure the seller they will receive payments. All kinds of letters of credit in Singapore are written in official documents upon agreement by both parties, after which they are taken to the financial institute for review. Both parties must review the terms and conditions, including deadlines and any other clause in the letter of credit.
After conducting a background check and eligibility, the financial institution awards the letter of credit to guarantee the seller receives their payment. The bank can make full or partial payments when the buyer sends a portion of the payment to the seller.
If the letter of credit is negotiable, the bank issuing the letter of credit pays the beneficiary or a secondary bank nominated by the beneficiary. The beneficiary can even assign the right to draw to a third party if the letter of credit is transferable.
However, the buyer must prove to the bank that they have sufficient lines of credit or assets to pay them before they get the letter of credit. The buyer can pledge securities or collateral cash.
While it is typical for letters of credit to be used in international trade, many businesses in Singapore also use them in facilitating local trade transactions.
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Compliance With International And Singaporean Regulations
Note that all letters of credit in Singapore are overseen and regulated by the International Chamber of Commerce’s Uniform Customs and Practice for Documentary Credits.
Cost Of A Letter Of Credit In Singapore
Note that you’ll incur costs on a letter of credit, typically a percentage of the credit you want to obtain. However, the cost varies depending on the letter of credit and the bank. The average cost charged by Singaporean banks is 0.75% of the credit they guarantee. However, the cost can increase to 1.5% of the purchase price when you sum up other expenses.
Also, depending on the letter of credit, you may incur varying charges. For instance, you’ll incur more for a confirmed letter of credit than you’ll incur for an unconfirmed letter of credit.
In addition, you may also incur other miscellaneous costs and expenses, including:
- Opening charges
- Commitment expenditures
- Issuance fees
- Consultory expenditure
- Validating bank fees
While the buyer incurs most of the cost, the seller can incur some costs, including courier, wire transfer, and bank fees. Also, it is good to remember that some banks require the buyer to make an initial deposit, usually a percentage of the purchase price. This deposit in Singapore averages 1% of the purchase price.
Types Of Letters Of Credit In Singapore
There are different types of letters of credit in Singapore. Below, we take a look at some of the most common ones.
Commercial Letter Of Credit
In this type of letter of credit, the bank directly pays the beneficiary. This letter is used to facilitate commerce or trade in Singapore.
A commercial letter of credit is issued to facilitate trade or commerce. The issuing bank only draws drafts when the involved parties consummate the underlying transaction as intended. If not sold for cash, the commercial letter of credit will represent contingent liabilities.
Revolving Letter Of Credit
Singaporean businesses dealing with multiple transactions should opt for this type of letter of credit. This letter of credit allows the beneficiary to make several payments back-to-back within a specified timeframe. Singaporean importers who opt for this option can make multiple payments when making frequent shipments without redrafting or editing the original letter of credit.
Traveller’s Letter Of Credit
An issuing bank offers the traveller’s letter of credit to its beneficiaries, allowing them to make drafts according to the specified terms. It benefits Singaporeans who wish to go abroad and continue their trade transactions while abroad. The issuing bank permits the beneficiary to make draws at specific foreign banks. It is important to note that this letter is usually sold for cash.
Confirmed Letter Of Credit
Parties involved in this type of letter of credit are the seller, buyer, issuing bank, and a secondary bank (confirming bank). The confirming bank, usually the seller’s bank, makes the payments to the seller if the buyer and the issuing bank default. This arrangement is typical in international transactions, and the issuing bank may request so. This kind of arrangement minimises the credit risk to the beneficiary.
Other Types Of Letter Of Credit Specific To Singapore’s Trade Needs
- Standby letter of credit
- Revocable letter of credit
- Irrevocable Bank Credit
- Unconfirmed letter of credit
- Back-to-Back Bank Credit Letter
- Red Clause Payment guarantee letter
- Transferable Letter of Credit
- Non-transferable Payment guarantee letter
Example Of A Letter Of Credit In Singapore
Citibank is one of the financial institutions that offers letters of credit to Singaporeans. Singapore businesses facing challenges obtaining international credit can approach this financial institution for aid. Their letter of credit has helped many exporters against Singaporean importers’ counter risk.
The bank provides its letters of credit within two business days. Citibank branches, which usually act as confirming banks, guarantee payments to the beneficiaries.
Benefits Of Letter Of Credit In Singapore’s Economic Climate
The Citibank letter of credit has helped global traders in Singapore and beyond reduce overseas risks while undertaking international transactions. Thus, sellers receive on-time payments and total amounts, while the buyers in Singapore can run their operations smoothly. The whole process contributes to an active economic climate fostering development.
How To Apply For A Letter Of Credit In Singapore
Below is the process of applying for a letter of credit in Singapore.
- The buyer approached his bank for a letter of credit. Singaporean importers approach their bank for the LC if the exporter demands an upfront payment.
- Letter of credit application form. The buyer completes the application form, after which the issuing bank verifies the details. The complete form is then sent to the beneficiary for approval.
- Letter of credit evaluation. The advising bank evaluates the letter of credit granted by the issuing bank and advises the beneficiary on the next cause of action (shipment of merchants in an import-export scenario).
- Exchange of products and documents presentation. The seller initiates the transfer of the goods to the buyer. In return, they receive the shipment documents presented to the confirming bank for upfront payments. The confirming bank verifies the documents and sends them to the issuing bank.
- Payment fulfilment. After verifying the documents, the issuing bank pays the seller (exporter) their total amount.
Documents Required For LC
A letter of credit requires the following documents.
- Commercial Invoice
- Importer’s financial documents
- Landing airway bills or cargo receipts
- Bills of exchange
- Certificate of Origin
- Packing, shipping, and transport documents
Advantages And Disadvantages Of A Letter Of Credit In Singapore
A letter of credit has both advantages and disadvantages, as shown below.
- It ensures efficient and streamlined transfer of funds and trade transactions.
- It allows Singaporean traders and newly established businesses to trade with partners in the global arena.
- Letters of credit are used to cushion buyers and sellers against bankruptcy as the buyer’s credit worth is transferred to the issuing bank.
- It allows the buyers and sellers to develop a mutual clauses list and strengthen their contractual relationship.
- Cushions the seller against disputes as they can withdraw their funds from the issuing bank before resolving the dispute.
- It clarifies the payment specifics, that is, time and mode of payment.
- There can be fraud risks as the issuing bank only verifies the shipping documents before making payments and not the quality of goods.
- The expiry date on the letter of credit can bring confusion and misunderstanding, especially if the beneficiary fails to execute the letter of credit within the time limits.
- The letter of credit could also miss significant transaction details, leading to errors.
Additional Information For Singapore
How a Letter of Credit Works in Singapore’s International Trade
In Singapore, a letter of credit assures the seller that they will receive their payments on time and in total amount. However, the issuing bank will charge a fee, usually a percentage of the buying cost. The buyer must also provide collateral.
A typical scenario is an exporter in an unstable economic environment. In this case, an issuing bank may grant the buyer a letter of credit. The bank’s branch guarantees the purchase. Since the bank has a pre-existing relationship with the buyer, it is well-informed of the buyer’s creditworthiness. Therefore, they can determine their eligibility for the letter of credit.
Differences Between Types in Singapore’s Context
Since there are different types of letters of credit, they can be confusing. For instance, commercial letters of credit allow the bank to make payments directly to the beneficiary. On the other hand, a revolving letter of credit allows the beneficiary to make multiple draws within a specified period without altering the original letter of credit.
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