Understanding Why Sellers Opt for Deferred Letters of Credit Instead of Immediate Payment

When it comes to international trade, letters of credit (LCs) are used to ensure that sellers receive payment after delivering goods or services to buyers. However, not all sellers will accept an LC payable at sight and instead may request a deferred LC. This article will explore the reasons behind such a choice and the implications it has on both buyers and sellers.

Why Sellers Prefer Deferred Letters of Credit

Sellers often opt for a deferred letter of credit (deferred LC) because it allows them to delay receipt of payment. This is done for several strategic reasons, including:

Strategic Foreign Exchange Management

The most common reason for a seller to request a deferred letter of credit is to manage foreign exchange risks. Devaluation of a country's home currency in the near future can be a significant concern for sellers. By delaying receipt of export proceeds, a seller can take advantage of higher exchange rates if the devaluation occurs. This strategy is particularly useful in volatile economic environments where currency fluctuations are a common occurrence.

Anticipating Exchange Rate Revaluation

On the other hand, if a seller anticipates a revaluation of the home currency, they may prefer to receive payment in advance or at least immediately on shipment of the goods. Paying in advance or at shipment can help sellers avoid potential losses due to anticipated revaluation.

Interest Rate Considerations

Another key factor in favor of a deferred letter of credit is the opportunity to earn higher interest rates on deferred payments. The interest earned on these deferred payments can offset some of the costs associated with the sale, thereby making the deal more profitable for the seller. This is especially important in periods of high interest rates or when the seller has access to alternative investment opportunities that offer higher returns.

The Role of Terms and Agreements

It is important to note that the decision to use a deferred letter of credit is not only based on strategic considerations but is also heavily influenced by the terms and agreements set between the buyer and seller. In many cases, the buyer may push for immediate payment, leading to the need for the seller to negotiate the specifics of the payment terms.

Conclusion

Choosing between an immediate payment and a deferred letter of credit is a critical decision that involves careful consideration of foreign exchange risks, interest rates, and strategic planning. While immediate payment provides immediate liquidity, deferred letters of credit offer a way to hedge against foreign exchange risks and potentially increase profitability. Both buyers and sellers must weigh these factors based on their unique circumstances and goals.

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