What Factors Affect the Cost of a Letter of Credit?
The use of a letter of credit (LC) in managing various types of transactions involving international trade is very common. Typically initiated by the buyer and processed through a financial institution, the cost of a letter of credit will be based on the standards and evaluation factors used by that institution in determining the level of risk involved with providing this type of financial service. Issues such as the total amount of the letter of credit, the current credit rating of the buyer, and the amount of trade fees and charges that apply to the specific deal will often have some relevance to how much the buyer actually pays for receiving this type of financial assistance.
As with many types of financial offerings provided by banks and similar institutions, the cost of a letter of credit will be influenced by the standard fees and charges that the institution charges. Most institutions will have a baseline or standard set of fees that apply regardless of the credit-worthiness of the applicant. These fees may include an application fee as well as other standard charges that are assessed as part of the servicing of the letter of credit for the duration of the document.
Along with standard fees and charges, the cost of a letter of credit may also address additional fees that are imposed due to the credit standing of the applicant. These additional fees are designed to protect the bank from some of the risk involved with doing business with certain clients who are considered to not have ideal credit. The actual cost of these additional fees will vary, based on the bank’s assessment of how much risk is actually involved.
A third factor that can affect the cost of a letter of credit involves any ancillary charges that may be required by the receiving bank in order to accept the LC as guarantee of payment to follow once the seller has processed and delivered the order to the buyer. Typically, these fees are bundled into the total amount of the letter of credit, and are forwarded as part of the total payment once the order is received. The actual amount will depend on what type of trade fees are assessed by either the country of origin or the country that actually receives the goods associated with the order.
Since the cost of a letter of credit can vary somewhat from one institution to the next, buyers can and should compare terms and prices with several different banks. Doing so can result in incurring fewer fees and saving a significant amount of money. At the same time, making sure the letter of credit is acceptable to the receiving bank is very important, since the idea is to make sure the purchase between the buyer and seller is completed in the most efficient manner possible.
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