The importer and exporter agree that payment will be made using a letter of credit and agree the terms under which payment will be made. The importer places its order and then approaches its bank and asks it to issue an L/C to the exporter’s bank. This gives the exporter’s bank a guarantee that the importer’s bank will make the required payment when the goods have been received at the buyer.
This is the risk that the government of the importing country will introduce measures, such as the introduction of capital controls, to prevent money leaving the country and hence from allowing the buyer to pay the exporter.
An importer faces the risk of non-delivery if they make payment in advance. Banks step in to break this impasse by providing guarantees of payment to exporters when the goods are delivered to the buyer.
The most basic and common form of this guarantee is the “letter of credit”, commonly referred to as an L /C. This is a highly standardized contract and is internationally recognized. It is treated as a contingent liability by the issuing bank as payment is conditional on a number of conditions being met.
This is the risk that the importer is unable or unwilling to make the payment due. Pursuing a company through the courts in a foreign country is likely to prove an expensive and time-consuming undertaking and has no guarantee of success.