If you are involved in international trade, you may have encountered letters of credit (LCs) as a payment method. LCs are financial instruments that guarantee payment from a buyer to a seller, as long as the seller meets certain conditions. LCs can reduce the risk of non-payment, fraud, and currency fluctuations, but they also come with a cost. In this blog post, we will explain what are the different types of LC fees, who pays them, and how to minimize them.
Types of Letter of Credit Fees
There are two main types of LCs: commercial and standby. Commercial LCs are used as a primary payment mechanism, while standby LCs are used as a backup in case the primary payment fails. Depending on the type of LC, the fees may vary.
Some of the common Letter of Credit fees are:
- Issuance fee: This is the fee charged by the issuing bank (the buyer’s bank) for opening the LC. It is usually a percentage of the LC amount, ranging from 0.75% to 1.5%, depending on the country, the risk, and the duration of the LC. The issuance fee is usually paid by the buyer, unless otherwise agreed.
- Advising fee: This is the fee charged by the advising bank (the seller’s bank) for notifying the seller of the LC and verifying its authenticity. It is usually a flat fee, ranging from $25 to $150, depending on the bank and the country. The advising fee is usually paid by the seller, unless otherwise agreed.
- Confirmation fee: This is the fee charged by the confirming bank (a third-party bank) for adding its guarantee to the LC, in case the issuing bank fails to pay. It is usually a percentage of the LC amount, ranging from 2% to 3%, depending on the risk and the duration of the LC. The confirmation fee is usually paid by the seller, unless otherwise agreed.
- Amendment fee: This is the fee charged by the banks for making any changes to the LC, such as extending the validity, increasing the amount, or modifying the terms and conditions. It is usually a flat fee, ranging from $25 to $150, depending on the bank and the country. The amendment fee is usually paid by the party requesting the change, unless otherwise agreed.
- Discrepancy fee: This is the fee charged by the banks for handling any discrepancies or errors in the documents presented by the seller under the LC. It is usually a flat fee, ranging from $25 to $150, depending on the bank and the country. The discrepancy fee is usually paid by the seller, unless otherwise agreed.
- Handling fee: This is the fee charged by the banks for processing the documents and transferring the funds under the LC. It is usually a flat fee, ranging from $25 to $150, depending on the bank and the country. The handling fee is usually paid by the seller, unless otherwise agreed.
- Reimbursement fee: This is the fee charged by the reimbursing bank (a third-party bank) for transferring the funds from the issuing bank to the confirming or advising bank. It is usually a flat fee, ranging from $25 to $150, depending on the bank and the country. The reimbursement fee is usually paid by the issuing bank, unless otherwise agreed.
Who Pays the LC Fees?
According to the rules governing LCs, such as the Uniform Customs and Practice for Documentary Credits (UCP 600), the bank instructing another bank to perform services is liable for any charges incurred by that bank. However, in practice, the allocation of LC fees is often negotiated between the buyer and the seller, and specified in the LC text.
The field “71B: Charges” in the LC text indicates how the LC fees are distributed among the parties. For example, if the field says “All charges outside Jordan are for the account of the beneficiary”, it means that the seller has to pay all the fees charged by the banks outside Jordan, such as the confirmation fee, the handling fee, and the reimbursement fee.
The allocation of LC fees depends on the bargaining power of the buyer and the seller, the market conditions, and the customs of the countries involved. Generally, the buyer pays the issuing bank’s fees, and the seller pays the remaining fees, unless the seller is in a very strong position against the buyer.
How to Minimize the LC Fees?
LC fees can add up to a significant amount, especially for large or long-term transactions. Therefore, it is important to minimize them as much as possible. Here are some tips to reduce the LC fees:
- Negotiate the LC fees with the banks: Before opening or accepting an LC, you should compare the fees offered by different banks, and negotiate for the best rates. You should also ask for a breakdown of the fees, and avoid any hidden or unnecessary charges.
- Negotiate the LC fees with the counterparty: You should also negotiate the allocation of the LC fees with the buyer or the seller, and try to shift some of the fees to the other party, if possible. You should also include a clause in the LC text that states that any additional fees due to amendments or discrepancies will be borne by the party responsible for them.
- Choose the right type of LC: You should choose the type of LC that suits your needs and minimizes your risk and cost. For example, if you are a seller, you may prefer a confirmed LC over an unconfirmed LC, as it provides an extra layer of security, but it also comes with a higher fee. You should also consider the duration of the LC, and avoid any extensions or renewals that may incur more fees.
- Comply with the LC terms and conditions: You should ensure that you comply with all the terms and conditions of the LC, and present the required documents within the specified time frame and format. You should also avoid any errors or discrepancies in the documents, as they may cause delays, rejections, or fees. You should also check the LC text carefully, and request any amendments or clarifications before shipment, if needed.
Conclusion
LCs are a useful payment method for international trade, but they also involve various fees that can affect your profitability. You should understand the different types of LC fees, who pays them, and how to minimize them. By doing so, you can navigate the LC fees more effectively, and optimize your trade finance.
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