Letter of Credit Forum

Letters of Credit blamed for collapse of international trade Several bloggers (see here) claim that the collapse of the Baltic Dry Index (an index of the cost of chartering bulk cargo vessels for goods like ore, cotton, grain, etc.) is the result of the collapse of trade credit based on letters of credit.

I believe these views to be incorrect. Letters of credit are just one way of financing (international) trade. Among the choices are factoring, forfait financing, prepayment by the buyer, payment terms net 30 after receipt of the goods. Nearly all of these are affected by banks raising their lending requirements. Some banks require 100 % of the LC amount in a separate bank account. Under these circumstances, applicants have difficulties obtaining credit, any credit.

It might come to pass that we will see a competitive pricing of trust. Trust in this case is the belief of a creditor that the debtor will comply with his or her payment obligation. Since banks are displaying a lack of trust as evidenced by their requirements, they might price themselves out of the market.

Buyers and sellers could include a risk premium in the purchase price and forego banking assistance, thus putting a lower price on trust between seller and buyer and displaying a higher degree of trust between each other than banks are willing to do.

In the end, the market place will decide, whether the trust premium requested by banks or the trust premium negotiated between international buyer and seller actually reflects market conditions.

It seems however, that at least US banks swing from one extreme to the other. A couple of years back, banks were willing to extend credit to any poodle showing up at a branch; now banks only accept cash collateral (at least that is what Wells Fargo confirmed). Taking furthermore into consideration that banks have taken the government bailout money to buy other banks instead of extending credit and that they have invested their investable reserves in government bonds with negative yields, banks seem to exit the business of banking. (Anyone in the industry, please provide updates).

Maybe, the time has come for creative and negotiated solutions that assess risk and trust more accurately than banks are willing to do.