At sight LC is a documented contract that enables immediate payment to the seller or exporter. The seller or exporter must fulfill the requirements agreed upon in the trade contract. A sight letter of credit is used to shorten the payment period for the exporters.
With a normal letter of credit working, the exporters receive funds upon the goods confirmation from the importers. An irrevocable LC or a standby LC usually works that way. These arrangements put the exporters at a disadvantage of delayed fund receipts. One way of reducing the risk of cash crunch for the sellers is to use the At Sight Letter of Credit arrangements with the buyers.
Table of contents
What is At Sight Letter of Credit?
Letters of credit are separate documentary credits from the trade contracts between the two parties. A letter of credit is issued to secure the payment terms. Depending on the trade contract, the payment may take several business days to finally reach the beneficiary. An At sight letter of credit provides a quick payment method with payment receivable as quickly as the goods get shipped.
It is likely to take place between two regular trade partners as it requires significant trust. The buyers allowing the sellers to receive payments quickly (after shipment) face the risk of the damaged or wrong goods delivery. The issuing bank, however, confirms the correctness of accompanying documents. The document verification by the bank may take a few business days before the sight LC funds are released.
How does it Work?
A letter of credit secures both parties in a trade contract with the help of an intermediary i.e. a bank. With a traditional letter of credit mechanism, the payments to the beneficiary may get released after presenting the goods inspection certificate. For international trade, it requires significant time to ship the goods or complete large projects. A sight LC reduces the wait time for the sellers.
The general working approach for an At Sight Letter of Credit is similar to any LC issued:
- The buyer proceeds with an application for issuing a sight letter of credit
- The issuing bank authorizes the sight letter of credit upon credit assessment of the applicant
- The bank forwards the sight LC to the advisory bank and verifies the terms from the beneficiary through the bank
- The seller upon confirmation issues the goods or supplies to the buyers
- The seller as agreed upon for the Sight LC, may present the shipment documents
- The advisory bank forwards the documents to the issuer bank
- The issuer bank reviews the contract terms and may decide to release the funds
With an At Sight LC, usually, the issuer bank forwards the funds as soon as the shipment documents are presented. The bank may need a few business days to verify the documentation though.
Why Use an At Sight Letter of Credit?
The special form of at sight LC reduces the payment clearance time for the seller. Well established trade partners may use this type of letter of credit. Apparently, the terms favor the seller only, however, all parties involved can benefit from the at sight LC contracts.
Benefits for the Exporter
The At Sight LC beneficiary may be an exporter or a domestic service provider. An At Sight LC provides additional cash benefits to the beneficiary. The cash requirements may become significant in large goods processing orders or large projects. The sellers require significant cash funds upfront to buy raw materials and other costs.
Receiving funds faster from the buyer also increases the seller’s negotiating powers with their manufacturer or raw material providers. It saves them interest costs for avoiding additional bank financing for project completion. It reduces the risk of default with the new buyers.
Benefits for the Buyer
The foremost benefit the buyer can take is to negotiate better pricing terms with the seller. A small price negotiation may yield competitive pricing advantages to the buyers. It will also improve the creditworthiness of the buyer amongst other trade partners.
The buyer may attach certain covenant with At Sight LC too. For example, document verification from shipped goods may come from a trusted third-party institute. To further reduce the risk of receiving damaged goods, the buyer may take additional steps such as insurance of the goods shipped. Another way is to appoint an institutional third-party inspection before the goods get shipped. Such steps can safeguard the buyers’ interest as the sellers are usually more secured with an At Sight LC mechanism.
The buyer can also opt to combine the At Sight LC features with a time LC. A time LC will allow a specific window before the fund’s release and by the time goods actually reach the destination. However, with a time LC the issuer bank may not hold the funds after the specified period.
Drawbacks of At Sight LC
As with any type of a letter of credit, the At Sight LC also presents some drawbacks. The common drawback with any LC is that it does not guarantee the payments under certain circumstances. Although a letter of credit reduces the risk of default of buyer, it does not eliminate the risk of payment failure completely.
Some specific drawbacks associated with an At Sight LC include the following:
- The sellers may not receive the funds as quickly as they anticipate. As the bank may need time to verify the goods shipment and other documents.
- The buyer may attach additional covenants that widen the payment window practically eliminating the advantage of At Sight LC
- The buyers may not get the negotiating powers anticipated and may not receive the discounts they anticipate
- The sellers may still face the risk of default under certain conditions with volatile economic or geopolitical conditions
- The buyers face the risk of receiving faulty goods or lower quality services
- The buyers may have to incur additional insurance or third-party inspection costs before the shipment of the goods
A letter of credit usually protects the buyers’ (importers) interests. At Sight Letter of Credit offers an additional layer of security to the sellers (exporters) too. The exporters receive funds faster with At Sight LC than normal credit documentary contracts.