Letters of credit (LCs) offer a way for exporters to secure financing from other firms. These letters of credit are valuable tools for minimizing risk in an uncertain trade. Although their usage varies depending on product type, some exports are more resilient in times of uncertainty. During times of financial crisis, however, distressed banks may limit the supply of LCs to companies. Therefore, if your export business is highly vulnerable to such risks, international trade credit can help minimize your risk.
While limiting risk and maximizing returns, international trade credit has the added benefit of avoiding a trade war. It is important for countries to avoid escalating trade tensions, but it is also important to remember that even a small increase in trade tariffs will have negative consequences for exporters. Therefore, it is vital that governments commit to not imposing new trade restrictive measures in order to protect their companies and avoid further damage to their economies.
In an international trade, a letter of credit, or LC, is the most secure instrument. A LC is a bank’s commitment to pay the exporter before the goods are shipped. The exporter establishes credit with the bank, pays the bank to issue the LC, and if the buyer fails to pay on time, the LC protects the buyer. A letter of credit protects the buyer in the event of nonpayment, but it also provides a guarantee to the exporter that the payment will be made.
A global economic situation is a major cause for international trade uncertainty. New data suggests that higher trade activity isn’t necessarily discordant with global uncertainty. In fact, it may benefit countries that are pursuing higher consumption levels. In this way, trade helps distribute the risks between countries and companies. When done properly, it can help minimize risks and increase opportunities for companies. Even countries with weaker economies may be able to take advantage of uncertain global trade.
A country’s risk is assessed on a scale of 0 to seven. Countries that have low risk and high risk are classified accordingly. Banks will then assign a country’s risk to protect their exporters. The OECD website provides information on the country’s risk profile. Depending on the risk profile, credit insurance may be worth considering. But bear in mind that even if a customer does pay on time, they will not get 100% of the money.
Another factor affecting international trade is currency volatility. If a country imposes currency controls, it can negatively affect import and export activity. In addition to currency fluctuations, trade uncertainty can also lead to geopolitical risks. If a country’s currency devalues, it will affect all businesses, including U.S. companies. For example, a Brazilian government could impose a tariff on U.S. companies. If a country’s currency depreciates against its currency, U.S. businesses in Brazil would be unable to receive payments from their foreign partners. Because of this, businesses operating in emerging markets need to prepare for the potential risks and identify optimal hedging instruments.
Banks must be vigilant about the risks of fraud. Fraudsters will exploit any opportunity to steal money. As a result, banks are increasingly aware of the risk of financial crimes and have implemented measures to reduce the risk of fraud and terrorism. In addition, global trade has already become more exposed to trade wars, geopolitics, and COVID-19. These are just a few of the challenges.