In international trade, a usance letter of credit is a valuable financial product that allows companies to purchase goods on credit. It is also known as a deferred letter of credit. The word "usance" refers to the period of time allowed for the payment of bills. The duration usually ranges from two weeks to two months. For example, a company can purchase raw materials from an agro-based company and receive the goods before the complete payment is made. Depending on the type of usance bill that was issued, the company might have up to 30 days to make the full payment for the received goods.
Usance also means the interest that is charged on loans. In this case, when a person borrows money, the creditor will charge a usance in exchange for his financial aid. In other words, usance is the profit made on the invested principal. There's a lot more to the usance letter of credit. Below are the key things you need to know about it.
Only Credible Individuals Can Apply
Customers must satisfy all the requirements stated by the issuing bank or institutions before they are considered for the usance letter of credit. They must have a good financial history and, sometimes, good collateral security. The approval process is thorough so It might take a while, depending on the institution.
Facilitates Trade
There is usually a lack of trust in business transactions. Both parties are wary and skeptical, especially in international trade. A usance letter of credit is one of the mechanisms used to facilitate smooth international business transactions and mitigate the risks involved. Certain conditions are set and have to be fulfilled in order to make both parties comfortable and under less pressure.
Buyer Has an Upper Hand
The buyer stands to reap most of the benefits that the usance letter of credit offers. For starters, the buyer gets an interest-free capital which means he can effectively manage his working capital. The buyer could also receive his goods even before making any initial payment. This means that business can proceed faster. Also, he can properly assess the quality of the goods before making payment.
Manage Capital and Cash Efficiently
Because the seller won't get paid until later, he has to manage his wiring capital more efficiently. This might affect his other transactions. You can see that the buyer has the upper hand in this case.
Additional Source of Liquidity for The Importer
The usance LC increases the number of liquid assets that the importer has. This is because the payment for the goods can be deferred for up to 1 year, in some cases. Also, the interest rate is lower than other finance products.