India is one of the largest exporters in the world, and the contribution of growing MSMEs doesn’t stop there. In fact, the latest reports suggest 45.56% of national exports were done by MSMEs from April ’23 to September ’23. While this upscale seems to be fantastic, the journey is filled with international trade challenges.
Nevertheless, ensuring seamless international business can be easy by leveraging the right trade finance solutions, like an Export Letter of Credit (LC). It acts as a financial guarantee, giving you peace of mind while you focus on expanding your global footprint. Let’s learn more about this financial product and how it can ease your international trade venture.
What is an Export Letter of Credit?
An Export Letter of Credit (LC) is a trade finance instrument issued by your bank on your behalf to a foreign buyer. It guarantees payment upon fulfilling specific conditions. This may typically involve the shipment of goods and the presentation of required documents like invoices, bills of lading, and certificates of origin.
How Does an Export Letter of Credit Work?
An LC begins functioning when the importer applies for one from their bank, specifying the payment terms and documentation required. Once the LC is issued, the exporter’s bank reviews it to ensure it matches the agreed terms.
Afterward, the exporter would ship the goods and submit the necessary documents. Upon verification of the Export Letter of Credit, the documents shall be forwarded to the importer’s bank.
If everything is in order, the importer’s bank releases the payment to the exporter’s bank. This mechanism provides security for both parties.
In the case of Indian MSMEs entering the international trade market, here’s a simplified breakdown:
- Exporter (You): The Indian company selling goods internationally.
- Applicant’s Bank: Your Indian bank that issues the LC.
- Issuing Bank: The applicant’s bank acts on your behalf, establishing the LC with the foreign buyer’s bank.
- Beneficiary’s Bank (Confirming Bank): The foreign buyer’s bank that receives the LC and ultimately makes the payment.
Benefits of Using an LC for an Exporting MSME
There are different trade finance services available in India when it comes to supporting exporting MSMEs. Nevertheless, LC stands out because of its efficiency in ensuring timely payments and some other aspects. Here are some of its noteworthy benefits:
- Reduced Risk: An LC minimises the risk of the buyer’s non-payment. You receive payment as long as you fulfil the agreed-upon terms.
- Enhanced Credibility: An LC showcases your business’s credibility and financial stability to the foreign buyer, facilitating smoother transactions.
- Improved Cash Flow: Receive timely payments upon shipment, improving your cash flow and business operations.
- Competitive Advantage: Offering an export Letter of Credit can help you with the negotiations. This is especially true when dealing with new buyers who may be hesitant to pay upfront.
- Access to Financing: Some banks might offer pre-shipment financing based on the LC, helping you manage working capital during the export process.
Exploring Types of Export Letters of Credit
There are various types of LCs catering to different needs and risk profiles. Understanding them will help you choose the most suitable one for your transaction:
- Documentary Letter of Credit: This is the most common type, relying on the presentation of specific documents for payment.
- Confirmed Letter of Credit: Here, your bank adds its guarantee to the LC, providing an extra layer of security for the exporter.
- Usance Letter of Credit: This LC allows for a deferred payment, granting the buyer a credit period after shipment.
- Revocable Letter of Credit: The issuing bank can amend or cancel this LC at any time, but it’s rarely used due to lower buyer confidence.
Important Considerations Before Using an Export Letter of Credit
- Costs: Issuing and processing LCs involve charges, including bank fees and confirmation charges (if applicable). Factor these costs into your pricing strategy.
- Documentation Accuracy: Careful document preparation is crucial. Any discrepancies may cause delays or even payment rejection.
- Communication is Key: Clear communication with your bank and buyer throughout the process ensures a smooth transaction.
Other Trade Finance Services Exporting MSMEs May Require
Indian MSMEs can access various finance services when conducting international trade via MSME banks. Here are some of them you must know to leverage for your export activities:
- Pre-Shipment Financing: It provides working capital for production and procurement before shipping goods.
- Post-Shipment Financing: This service offers immediate funds upon shipping, bridging the gap until payment is received from the buyer.
- Export Credit Insurance: Similar to an export Letter of Credit, it protects against the risk of non-payment by overseas buyers, ensuring financial stability.
- Bill Discounting: It allows MSMEs to sell their receivables to banks at a discount, improving cash flow.
- Bank Guarantees: They assure foreign buyers of payment reliability, fostering trust in business transactions.
Start Your Exporting MSME Business Today!
MSME banks cater to businesses involved in international trade, especially exports, in various ways. This includes traditional borrowings, bank guarantees, etc., but there are also some specialised services, like an export Letter of Credit.
For such finance services, you must connect with a reliable MSME bank like HDFC Bank. With years of reputation that they have, their range of financial products for any MSME business is beyond imagination. Plus, you get full support at every step of the process of obtaining an LC.
Visit HDFC Bank’s official website to learn more about their LC and even get it online for your exporting MSME business today!
