What is NOT a benefit of a Letter of Credit?

A Letter of Credit (LOC) is a financial document issued by a bank that guarantees payment to a seller on behalf of a buyer, provided that the seller meets the terms and conditions outlined in the LOC. While it offers several benefits to both parties involved in a transaction, one aspect that is often misunderstood is the associated costs.

The primary benefit of a Letter of Credit includes offering security in international transactions, which reassures sellers that they will receive payment even when dealing with unfamiliar buyers or markets. Additionally, it facilitates trade with new customers by reducing the perceived risks involved, making it easier for sellers to engage with parties they have not previously worked with. It also plays a crucial role in mitigating the risk of non-payment, as banks back the transactions, providing confidence to sellers.

However, despite these advantages, the cost associated with obtaining a Letter of Credit can be higher than other methods of payment, such as cash in advance or open account arrangements. Fees may be incurred during the issuance, negotiation, and confirmation of the credit, leading to the conclusion that a Letter of Credit may not necessarily have lower costs compared to alternative payment methods. Thus, recognizing the cost aspect is vital when evaluating the use of Letters of Credit in trade.