What is an Export Letter of Credit?

How Can It Help My Business?

For a small business, expanding overseas is never easy. It becomes all the more challenging if the small business in question is based in the Middle East. Even for small businesses in the UAE - a country without conflict - the perception of the Middle East by Western countries may lead to skepticism from customers. Western buyers may refuse to pay for goods until they arrive. Even when a customer pays upfront, political, or economic issues in the buyer’s region may prevent the transaction from being completed. In situations like these, an export letter of credit becomes an advantage. As we will discuss, an export LC primarily protects an exporter against non-payment by a customer.

A letter of credit can be difficult for small businesses in the UAE to secure. For this reason, small business owners are advised to seek the help of a trade finance agency before applying for one. A reputable agency, such as Credico Capital, will guide you through the application process and issue an LC on time. Unlike some other trade finance agencies in Dubai, Credico Capital deals with both import and export LCs.

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Export Letter of Credit

How Does It Work?

Bank Guarantee / Letter of Guarantee

An export letter of credit is more or less an insurance policy. It helps to ensure that the seller will be compensated for their goods or services when they are dealing with an overseas party. By doing so, an export LC allows unfamiliar importers and exporters to build trust and, in many circumstances, forge a lengthy working relationship. It also provides the exporter with the confidence needed to commit themselves to the project entirely.

When a seller requests an export letter of credit, they may enlist a trade finance agency to negotiate with the buyer on their behalf. The buyer, meanwhile, may turn to a trade finance agency of their own. The banks of both the importer and the exporter will likely be involved in this process as well. Once all parties have agreed on the terms of the LC, it is drawn up and made official.

Why Should I Consider One?

Bank Guarantee / Letter of Guarantee

As mentioned, the primary advantage of an export letter of credit is that guarantees made to the exporter. However, there are many other additional benefits to obtaining an export LC. If you produce custom made goods, you can be sure that this heightened devotion will result in higher quality products. Likewise, your staff will perform with greater enthusiasm once they are confident you have the means to pay their salaries.

Small businesses, particularly those in their early days, regularly work with first-time clients. An export LC will help develop a higher level of trust between both parties. In short, an export LC will help to turn your first-time customer into a repeat client. When this becomes a reality, you should consider pursuing a revolving letter of credit.

But Is It Necessary?

Bank Guarantee / Letter of Guarantee

For many small businesses, keeping their expenses to a minimum is the key to survival. As a result, some small business owners in the United Arab Emirates may be reluctant to spend money on a trade finance agency. Instead, they may choose to pursue an export letter of credit independently. Unless you are an export LC expert, this is not a good idea. If your buyer consults a trade finance agency when you request a letter of credit, they will likely be able to draw up a deal which heavily favors them. Without a trade finance agency such as Credico Capital in your corner, you may end up agreeing to such a contract.

Some exporters even choose to forgo an export letter of credit altogether. While this is somewhat understandable when trading with a long-time client, neglecting to pursue an export LC with a first-time customer is a significant risk. With nothing to protect you in the event of non-payment, you will incur the full financial loss if there is a problem with the customer’s payment. It can also severely impact your ability to continue production and pay your staff, leading to disastrous consequences for your business.

What About Export Credit Insurance?

Bank Guarantee / Letter of Guarantee

For those who would like to consider alternatives to an export LC, there is export credit insurance. Much like an export letter of credit, export credit insurance is designed to protect sellers should a problem arise with an overseas transaction. However, it requires you to pay a premium to an insurance company. This premium could cover anything from a single invoice to every single purchase with an overseas buyer.

Should a customer fail to send a payment for goods even after shipping, your policy provider will supply you with compensation. The issue with export credit insurance is that most policies will not cover you for the full cost of the unreceived payment. Instead, they are more likely to pay in the neighborhood of 85% of what you’re owed. It's also worth noting that export credit insurance, unlike an export LC, is not suitable for larger transactions.