trade-financeIt’s my understanding that the Letter of Credit is the primary mechanism for providing the irrevocable transfer of large sums of money for the trade finance industry. They seem to me to be a sort of antiquated notion, an expensive slip of paper to be carried physically to another human being to transfer money — a check in a debit card world.
Of course, moving vast sums of money has its own complications. Are there any electronic systems available (or in the works) to do away with the Letter of Credit?
First the Letter of Credit is typically not carried over from person to person.
The Letter of Credit solves a problem of trust/risk between buyer and seller. If the buyer pays in advance, the seller may not deliver goods. If the seller ships fist the buyer may not pay. Chasing an international law suit will be more expensive in cases of defaults.
In Letter of Credit the buyer pays to his Bank and authorises to release payment on shipment from seller. The Buyers Bank informs the Seller’s bank a gaurentee to pay in case the seller ships. Thus on shipment, the seller produces the relevant shipping and other documents to his bank which gives it to seller’s bank and gets the money. The buyers bank gives the shipping and other documents to buyer who would need these to release the goods from customers/shipment companies/warehouse.
Most of the Letter of Credit are advised over SWIFT netwrok and are electronic. The need of paper at times is for terms and conditions of shipment.
There is a move by SWIFT by introducing TSU [Trade Service utility] that is trying to standardize the Purchase Order and Acceptance of same. The standard allows to raise PO electonically and accept that become binding to both. Once this becomes main stream, then some amount of paperwork can be done away with.
There may still be some amount of paperwork required to get the shippment details and documents required for customs cleareance etc.
Although still somewhat experimental in nature, Bitcoin easily allows for electronic transfers. Any Bitcoin user can send Bitcoins to any other Bitcoin user, and there are no practical limits to how large these transactions can be. This mechanism works the same way whether for large organizations transferring large sums of money or for individuals transferring tiny amounts.
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