Letters of credit: an approach based on the default risk

Abstract

The recent years have been marked by the increase of the international trade at a global stage; this can be explained by the disappearance of many customs barriers and by the lift of tariffs and quotas on imports for many products. In a current international context like the one that we are facing nowadays, banks play a crucial role in enabling international trade by guaranteeing international payments and reducing the risks in trade transactions. This paper consists of a brief analysis of the use of Letters of Credit in order to avoid the default risk, since the Letter of Credit is a very common means of payment used both in export and import operations. This study focuses on the Documentary Credit as a means of payment and it is also a study of the implications for the banks in this process. It deals with the role of banks in the processing of Letters of Credit. Specifically, this short study tries to analyze an export operation from Spain to Lebanon that has been processed with Banco Santander and that resulted in the non-payment of the amount established by the L/C due to an incorrect processing performed by the bank. The paper aims at underlining the importance of documents in international trade as well as the fact that it is of crucial importance to respect all the information established by the Documentary Credit. The genesis of this study is the result of my exposure to international trade activities and my desire to present my point of view regarding the use of Letters of Credit in international export operations.