Common Pitfalls to Avoid When Using LC , DLC, SBLC, Bank Guarantees

  Reports suggest that up to 80% of trade documents initially presented to the bank contain errors. The most persistent issue in international transactions involves letters of credit (LC), documentary letters of credit (DLC), standby letters of credit (SBLC), and bank guarantees.  Such tools have great features for risk control, as they also protect payment security. But even the most experienced know that using these tools is not devoid of problems.  What should you do to prevent these inevitable occurrences of errors while using these instruments?  In this blog, we will help you unravel what the common pitfalls are to avoid while using these instruments and how to navigate your international trade transactions smoothly. Let’s begin!

Letter of Credit & Bank Guarantee: A Risk Prevention Guide

1. Insufficient Due Diligence

When a documentary letter of credit (DLC) is used, there should be a due diligence process that includes checking the SWIFT codes, rating the bank based on information that has been confirmed, and reviewing the account performance history.

The Documentary Credit Letter of Credit (DLC) presents significant risks due to the hurried nature of document verification, which can lead to numerous discrepancies in the insurance certificate of coverage, shipping documents, and inspection reports. 

The UK reported a loss of £113 million in 2000 as a result of LCs with inconsistent documentation. Few developing nations, which form a third of the world trade, have faced challenges to open LCs. Bank guarantee transactions should observe legal enforceability across different jurisdictions. 

2. Poor Document Preparation

Another point where institutions often discover loopholes during the preparation of letters of credit, standby letters of credit, or bank guarantees is when commercial terms do not generally possess precise descriptions of payment, the time of shipment, or the presentation of the documents.  Discrepancies happen when there aren’t enough, clear, or descriptions of goods or services, when Incoterms aren’t understood, or when the shipping or insurance clauses use the wrong name. This means the documents can’t be accepted.  According to the International Chamber of Commerce (ICC), documented errors occur in 60–70% of letter of credit (LC) transactions. At the same time, ambiguity in the terms of performance or the obligations of the undertaking in the DLC / SBLC will lead to disputes, particularly to conditions of invocation which are not always adequately drafted.  Discrepancies in supporting documents such as bills of lading, certificates of origin, and inspection reports can be cited as non-compliance, making payment holdups and rejection of claims. 
Credit Debt

3. Timing and Expiry Issues

At the same time, ambiguity in the terms of performance or the obligations of the undertaking in the DLC / SBLC will lead to disputes, particularly to conditions of invocation that are not always adequately drafted. 

Discrepancies in supporting documents such as bills of lading, certificates of origin, and inspection reports can be cited as non-compliance, resulting in payment holdups and rejection of claims.

4. Incorrect Issuance Amount

An inaccurately stated issuance amount of Standby Letters of Credit (DLCs) and bank guarantees can, at times, lead to serious disputes and significantly impact the traded commodity. Wrong issuance sums can result in a loss of finance or the breach of contract in case it is with the underlying contract, and in that case, could lead to penalties and court proceedings. Liquidity problems affect developing countries that represent one-third of world trade.
Incorrect Issuance Amount

According to a joint report by the IMF and the Bankers’ Association for Trade and Finance, there has been an annual decline of more than 6% in trade finance flowing to developing countries, which was a steeper decline than that of trade volumes. 

Local bankers and survey estimates indicate that this points to a market shortfall that could surpass $25 billion.

Risk Management

  • Scrutiny: Thoroughly reconcile the issuance amount with the transaction terms to ensure its coherence.
  • Stakeholder Communication: Confirm the amount to have a say in the beneficiary, issuer, and bank witness the event so as to eliminate misunderstanding.

Technology and Automation

  • Software Solution Finance: Use automation to validate the amount in real time to reduce errors of human entry.

5. Technical Errors in Structure

Any errors in the construction of a Documentary Letter of credit (DLC), Standby letter of credit or a bank guarantee can lead to serious issues such as rejection of documents and non-compliance. 

Therefore, it is essential to ensure clarity in all the terms, conditions, and obligations that may apply to the stated contract. 

Moreover, other measures like cross-checking with legal, financial, and banking teams, as well as the use of automated systems for error detection, can reduce lapses in structural mistakes, increasing the chances of smooth transaction execution.

6. Security Vulnerabilities

Businesses are at risk when it comes to Documentary Letters of Credit (DLCs), Standby Letters of Credit (SBLCs), and Bank Guarantees used in international trade because they have security holes.
Security Vulnerability

DLCs include desired documents that must be presented to obtain payment and are exploited more than other financial instruments as far as frauds, cyberattacks, and unauthorized access are concerned due to the fact that the whole case involves many parties and digital platforms.

Pacific Corp- Your Trusted Partner in Trade and Finance

Our extensive network of industry contacts offers a wide range of services, including Letters of Credit (LCs), Standby Letters of Credit (SBLCs), Bank Guarantees, and Performance Guarantees. 

This will ensure the right financial instruments are present for your international trading transactions. 

Our expert team works closely with our clients to assist them in shortening the whole risk mitigation and trade cycle timeline. Whether you need financial consultation or assistance with a complex international trade project, Pacific Corp serves as your comprehensive partner.

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