Discounting of Letter Of Credit (LC) is a short term credit to the seller by the bank. The letter of credit is opened by the buyer in favor of the supplier for the supply of goods. At the end of the LC period, the supplier is paid through the LC. The supplier has to discount the LC with the bank and only then the money is realized and not immediately.
Thus a LC is a guarantee from the bank that a buyer’s payment will be made in full to the seller on time. In international trade, the Letter of credit is of prime importance as it bridges the gaps between the buyer and seller in spite of the distance, language, rules and laws, etc. Since this is a negotiable instrument, the issuing bank pays the beneficiary. There are many charges which are associated with the letter of credit. The confirmation cost, the discount or interest charge and other charges which include advising, negotiation, documentation charges etc.
The discounting or interest charge on letter of credit is paid by the supplier. And further as per the agreement, the buyer reimburses the discounting charges on letter of credit to the supplier.
The Letter Of Credit helps improve cash flows and receive payments promptly once the documents are accepted and compliant confirmed. As there is a guaranteed security, it benefits not only the seller but also the buyer and the bank. Thus funds are received as soon as there is a binding commitment from the buyer’s bank that the payment is due at a future date. Since the payment can be made after longer terms, LC gives the advantage of negotiation better deals. Also the suppliers can be paid early, thus a better pricing can also be negotiated.
For a relatively smaller discounting charge on the letter of credit, the benefits far outnumber the expenses and make the whole process simpler and faster.
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