Risks in letters of credit can be discussed under four groups; general risks in letters of credit, risks to the applicant, risks to t...
Risks
in letters of credit can be discussed under four groups; general risks
in letters of credit, risks to the applicant, risks to the beneficiary
and risks to the banks.
General Risks in Letters of Credit:
Country Risk: (Political Risk)
The
first risk factor that can be mentioned in the general risks group is
the country risk or the political risk. Let us assume that we are an
exporter located in a country X and we have a customer from the country
Y. Our customer, which is from the country Y, opened a L/C in favor of
us. We have checked the L/C conditions and they seem workable. We have
produced and shipped the order as per the L/C and transmit the required
documents to the issuing bank before the expiry date. The issuing bank
found our presentation complying and informed us that they will be
honoring our payment claim at the maturity date. However, before the
maturity date due Country Y has changed its export regime, which makes
it impossible for the issuing bank to honor our presentation. This
illustrative is a good example of a country risks. Other examples of
country risks are mass riots, civil war, boycott, sovereign risk and
transfer risk. 
Fraud Risk:
As
we have described before all conditions stated in a letter of credit
must be connected to a document, otherwise banks will disregard such a
condition. In addition, banks deal with only documents but not goods,
services or performance to which the documents may relate. This feature
of the letters of credit is the source of the fraud risk at the same
time. As an example, a beneficiary of a certain letter of credit
transaction can prepare fake documents, which looks complying on their
face, to make the presentation to the issuing bank. As the documents are
complying on their face, the issuing bank may honor the presentation
and in this case, the applicant must pay to the issuing bank for the
goods it will never be receiving. Beneficiaries of L/Cs bear also fraud
risks. This happens if an applicant issues a counterfeit letter of
credit. In this case, the beneficiary never receives its payment for the
goods it has shipped.
Risks to the Applicant:
In
a letter of credit transaction, main risk factors for the applicants
are non-delivery, goods received with inferior quality, exchange rate
risk and the issuing bank's bankruptcy risk.
Risks to the Beneficiary:
In
a letter of credit transaction, main risk factors for the beneficiaries
are unable to comply with letter of credit conditions, counterfeit L/C,
issuing bank's failure risk and issuing bank's country risk.
Risks to the Banks:
Every bank in a L/C transaction bears risks more or less. The risk amount increases as responsibility of the bank increases.
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