Is the Letter of Credit Waning?
But where is the letter of credit today? I’ve seen different sources of data suggest that trading activities involving the letter of credit are alive and well, despite a trend to open account trade. But others suggest both anecdotally and from third-party research that the L/C is on the wane.
There’s probably some truth to both sides of the argument, depending on how one defines the question. For example, are we counting absolute number of transactions, overall volume, new buyers or sellers, different or specific geographies or something else?
Still, a Barclays banker makes a great case in this TFX News article that L/C use is declining as non-recourse receivables finance growth accelerates. As he observes with open account trade, there has been a “dramatic shift from traditional trade instruments, such as import L/Cs, advanced payments or collections to open account terms with counterparties in recent years with close to 90% of all global trade transactions now being on an open account basis.”
Further, the growth of non-recourse financing programs is also contributing to the trend. For example, a survey conducted of Barclays clients found that “67% of corporates are seeing an increase in open-account trade and 35% of the companies showed that they were already running a receivables-financing program or were considering doing so in the near future.”
In part, this increase “is being driven by a rise in open-account trade, especially from suppliers in the development world, pushed by the major retailers/importers in the developed world, including the acceptance of factoring as a suitable alternative to traditional forms of trade finance.”
So where do observations and survey data like this leave the future of the humble L/C? I would argue the rumors of its death have been greatly exaggerated, thanks in part to technology automation.
Just as we have seen investments in accounts payable automation and e-invoicing speed up the approvals process to create a greater window to finance payables – and to create greater visibility financing an increasing number of transactions from both internal company balance sheets as well as third party-sources of capital – so too can related systems and online frameworks make the letter of credit a more efficient tool. All while keeping the protections it provides to parties – the main reason it originated in the first place!