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Banking

Letters of credit: Retreat from open account?

One area of increased interest in the wake of the credit crunch is traditional trade financing products such as letters of credit (LC). In recent years, trading has increasingly moved to open account rather than LC in a bid to lower costs. But Tan Kah Chye, global head of trade finance at Standard Chartered in Singapore, says that as supply chain participants have become cautious about the financial stability of their trading partners they have once again begun to consider LC.

Towards fewer, stronger chains?

As Stuart Nivison, head of trade and supply chain, Europe, at HSBC in London, notes, the move to open account from LC has been driven by a benign credit environment where counterparty risk was seen as minimal and could be financed cheaply. He says that the Asian financial crisis in the late 1990s could provide a pointer for the market. "After a few defaults in Indonesia, it became virtually impossible to obtain trade finance without bank intermediation and without the protection and key triggers for finance available through the likes of LC," he recalls. "While it is hard to imagine a major shift back to LC, looking at the inter-bank markets it is likely that we will see a move, if only for the medium term, towards banks re-intermediating to mitigate risk and provide more traditional trade finance."

And Axel-Peter Ohse, head of trade finance, Germany, at Deutsche Bank, notes that LC offer substantial advantages for corporates as well as banks in an uncertain and worsening risk environment. "Open account settlement requires elaborate vouchering, reconciliation and tracing processes, while LC offers easy risk management," he explains. "Most importantly, open account requires credit assessment capabilities on the part of the corporates involved.

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