What are the Benefits of Letter of Credit in Business in UAE?

By Sakshi Srivastava - 09 Mar 2022 Last Updated: 20 May 2022
What are the Benefits of Letter of Credit in Business in UAE?

Letter of credit is essentially a financial contract between a bank, a customer of the bank, and a beneficiary. The letter of credit, which is typically issued by an importer’s bank, guarantees that the beneficiary will be paid once the letter of credit’s conditions are met. By writing this blog Dhanguard will give you the information of Letter of Credit.

Letter Of Credit in UAE

Typically, a documentary credit or a letter of credit is used to finance international trade. Documentary credits have been referred to by judges as the “life blood” of international trade. The International Chamber of Commerce (ICC) Uniform Custom and Practice for Documentary Credit 500 and 600 govern the majority of documentary credits in international transactions.

The Commercial Transactions Law, Federal Law No. 18 of 1993, governs documentary credits in the United Arab Emirates (UAE). The provisions relating to documentary credit are found in section 4 of Chapter 3 of the Federal Law number 18 of 1993 Commercial Transactions Law, and they are not mandatory rules, but rather supplements to the parties’ intentions.

Use of Letter of Credit

Letters of credit are used to reduce risk in international trade transactions where the buyer and seller may not be familiar with each other.

Following are the uses of Letter of Credit

If you are an Importer

You can use a letter of credit to ensure that your company only pays for goods after the supplier provides proof that they have been shipped. It also allows you to conserve cash flow because there are no advance payments or deposits to make to the exporter. Finally, by demonstrating your creditworthiness, the letter of credit provides you with instant credibility with an exporter.

If you are an Exporter

The letter of credit serves as insurance in the event that the buyer does not pay for the goods you shipped. In such a case, the financial institution will pay the outstanding balance. The letter of credit also protects you from legal risks because payment is guaranteed as long as delivery conditions are met.

A letter of credit can also be pledged as collateral against working capital loans to help you fill your order if you are an exporter.

Parties Involved in Letter Of Credit

  • Importer - The applicant requests that the bank issue the letter of credit (LC).
  • Issuing Bank - the bank that issues the LC [also known as the LC opening banker]).
  • Exporter

What are the Basic Principles Governing Letters of Credit in the UAE?

Following are the principles that governs the letter of credit

Principle Autonomy

Documentary credit can be treated as a separate contract from the underlying sales contract under the Principle of Autonomy. The independence of a Letter of Credit can be considered an advantage in international sales because it serves as corporate assurance to parties involved in the international market in various countries.

If banks were allowed to refuse payment later under a Letter of Credit in a situation where a dispute had arisen between the trading parties, a significant flow of international trade would be stymied.

Doctrine of Strict Compliance

The Doctrine of Strict Compliance is the second important principle for Documents Credit. It is a requirement that the terms and conditions of the issues documents are met. The Letter of Credit will be deemed to be in accordance with the terms of the document and free of flaws.

Kinds of Letter Of Credit

Letters of credit are classified into two types under commercial transactions law:

Revocable Letter Of Credit

The credit in this type of letter of credit can be cancelled or amended at any time. Finally, it shall bear no liability in relation to the beneficiary.

The letter of credit is honored once the terms and conditions and documents are met. It is typically used to provide shipment guidelines.

Irrevocable Letter Of Credit

An irrevocable letter of credit cannot be revoked unless the beneficiary, issuing bank, and confirming bank all agree. It establishes a good working relationship between the bank and the beneficiary. As a result, this type of Letter of Credit provides the beneficiary with payment security.

Procedure of Letter of Credit

As a result, once the bank confirms the credit, the beneficiary or another correspondent bank at the beneficiary’s location will be notified. The correspondent bank will contact the beneficiary to obtain confirmation. As a result, it will be the responsibility of the correspondent bank to make payment to the beneficiary.

Advantages & Disadvantages of Letter Of Credit

These are the following advantages and disadvantages of Letter Of Credit

Advantages of Letter Of Credit

  • Both the seller and the buyer benefit from this security.
  • The buyer’s ultimate financial responsibility is assumed by the issuing bank.
  • Guaranteed payment allows the seller to borrow from the lender against the full receivable value of the transaction.

Disadvantages of Letter Of Credit

  • Typically covers single transactions for a single buyer, implying that a different letter of credit is required for each transaction.
  • In terms of absolute cost, working capital, and credit line usage, it is costly, tedious, and time consuming.
  • Additional security and collateral are required to satisfy the buyer’s bank’s coverage terms.
  • Long and time-consuming claims process involving additional paperwork for the seller.

Conclusion

The UAE has business deals all over the world, a letter of credit is more important in trade. A documentary credit transaction, also known as a letter of credit transaction, necessitates trust in banks. Both the buyer and seller should be confident that the bank will honor its payment obligations. A letter of credit instills trust in both parties involved in the transaction. Make contact with Dhanguard. We were here to help you with every aspect related to Letter Of Credit in UAE.

 

 

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Letter of Credit is a financial document that is used in international trade. It is a payment guarantee offered by the bank to the supplier of the goods.

By Sakshi Srivastava

09-Mar, 2022

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