GLOBAL SELLING BLOG

What is a deferred payment letter of credit?

In a deferred payment LC, the issuing bank releases payment to the beneficiary after a specified date. Learn more about its working and benefits in this blog.

In international trade, trust is an invaluable asset if you are looking to execute transactions successfully. However, conducting business across borders involves navigating complex legal systems and financial risks. Access to capital is essential for financing movement of goods and mitigating monetary risks. In this context, deferred letters of credit are a financial instrument that promote trust and facilitate smooth trade transactions.

What is deferred letter of credit?

A deferred letter of credit (LC), also known as a deferred payment letter of credit, is a type of document from a bank or a financial institution used in international trade. In a deferred letter of credit, the issuing bank releases payment to the beneficiary (usually an exporter/ seller) after a specified future date. The payment date is typically determined by the importer and corresponds to the maturity date of the trade deal. Unlike in other types of letters of credit, the deferred payment date cannot be set by the exporter. Instead, the exporter may negotiate the deferred payment date with the importer, taking into consideration factors such as production and delivery timelines¹.

Advantages of deferred payment letter of credit

The deferred LC offers significant advantages to both parties involved in international trade, making it a valuable instrument for new trade partners. Here are some of its key benefits:

Flexible payment terms:

The importer and exporter can negotiate and agree upon a deferred payment date. This flexibility enables effective cash flow and financial obligation management for both parties.

Goods condition assurance:

The importer can include a deferment clause in the LC, ensuring payment is made only upon satisfactory receipt of the goods.

Manufacturing confidence:

The LC confirmation offers the exporter greater certainty, allowing them to plan production and allocate resources confidently, minimizing potential disruptions.

Additional clauses and features:

The importer can include extra clauses or features such as performance, confirmation, or red clauses in the deferred LC, offering added benefits and security.

Disadvantages of deferred payment letter of credit

Although the deferred payment letter of credit offers certain advantages, it’s important to consider its limitations. Here are some key points to note:

Separate contract:

A deferred LC is a separate contractual agreement (distinct from the trade agreement) between the buyer and seller. Discrepancies or disputes related to trade terms may not be directly resolved through the LC, potentially adding complexity to the transaction.

Limited guarantee of trade terms:

Legally, a deferred letter of credit does not provide complete guarantee of adherence to trade terms for both parties. While it ensures payment at a future date, it does not address other aspects of the trade agreement, such as quality, quantity, or delivery condition.

Increased costs:

The inclusion of a deferred payment clause in the LC can lead to higher costs for the importer. The exporter may factor in the time value of money, charging higher prices due to the delayed payment terms.

Partial payment risk:

While a deferred LC mitigates the risk of non-payment, it does not eliminate it entirely. There is still a possibility of partial or delayed payment, which can strain the exporter financially and impact the importer’s trust and future business relationships.

How does deferred payment letter of credit work?

Deferred payment letters of credit facilitate trade transactions through a specific mechanism. Here’s a look at how it usually operates²:

1. Clear terms:

The letter of credit states deferred payment terms, including the date. The importer requests the issuing bank to issue deferred payment credit in favor of the exporter.

2. Credit with issuing bank:

The approved credit remains with the issuing bank or may be transferred to a nominated bank, such as the advising bank or exporter’s bank.

3. Production and shipment

Upon confirmation, the exporter produces goods and ships them, providing required documentation to the advising or nominated bank.

4. Payment release

The nominated bank verifies documents and compliance. If everything aligns, the bank releases the payment on the specified maturity date in the LC.

5. Maturity date setting

The importer often requests the issuing bank to set the maturity date after production begins, considering production, shipping, and delivery time.

Things to keep in mind about deferred letter of credit

Here are some key points to keep in mind about a deferred payment letter of credit:

Similar to sight LC:

A deferred payment LC operates similarly to a sight LC, but with the addition of a maturity date for payment.

Importer is in control:

The importer (and not the exporter) determines the specific maturity date based on factors like delivery time, production completion, and shipping events.

Negotiation:

The maturity date is subject to negotiation between the importer and exporter. The exporter cannot independently set the date with the issuing bank.

Fund release:

The nominated bank disburses funds to the seller only upon presentation of required documentation and strictly on the specified maturity date mentioned in the LC.

Deferred payment vs. usance letter of credit

A usance letter of credit and deferred payment letter of credit are essentially the same type of LCs with different names. In both cases, the bank disburses payment to the beneficiary on a predetermined date after the required documents are submitted. The terms “usance” and “deferred payment” are often used interchangeably in the context of LCs, referring to the delayed payment arrangement.

A deferred letter of credit serves as a financial instrument in international trade that enables delayed payment terms between the importer and exporter. Understanding the dynamics and considerations of a deferred LC is crucial for successful international trade transactions.

Amazon Global Selling: Easy e-commerce exports and hassle-free shipping

If you are a business owner and you want to sell your products from India to the world, Amazon Global Selling enables you to list and sell ‘Made in India’ products on 18+ Amazon global marketplaces acros the US, the UK, the UAE, Germany, Saudi Arabia, Australia, Japan, and more. As an e-commerce exports program, Amazon Global Selling provides support and guidance at every step of your exports journey – documents and licenses, logistics, payments, advertising, and more.

Registered sellers can choose to ship their products by themselves through Merchant Fulfilled Network (MFN) or they can opt for Fulfillment by Amazon (FBA) and outsource order fulfillment to Amazon including packing, storage, delivery, and returns. Amazon Global Selling simplifies the process of international shipping, helping businesses navigate customs and reach a vast audience.

Frequently Asked Questions

What is the difference between acceptance and deferred LCs?

An acceptance LC involves the buyer accepting a draft drawn by the seller, while a deferred LC allows for delayed payment based on a specified maturity date.

What is meant by deferred payment letter of credit?

Deferred payment letter of credit refers to a type of letter of credit where the bank releases payment on a specified future date, as agreed upon by the importer and exporter.

What is the purpose of deferred payment?

The purpose of deferred payment is to ensure the timely delivery of goods while providing financial security for both the buyer and seller by allowing the payment to be made at a later date, usually after the completion of production or delivery of goods.

Published on November 8, 2023.

Sources:
1. https://efinancemanagement.com/sources-of-finance/deferred-payment-letter-of-credit
2. https://www.cfajournal.org/deferred-payment-letter-credit/
3. https://www.accountinghub-online.com/deferred-payment-letter-of-credit/

International shipping with Amazon: Everything you need to deliver globally

What is a Letter of Credit at Sight?

Step-by-step guide to register with Amazon Global Selling

Guide to understanding Usance Letter of Credit

Sell across the world with Amazon Global Selling

Ready to start exporting from India?

Want to learn about Amazon Global Selling?

Here's your guide

Read more blogs

Disclaimer: Whilst Amazon Seller Services Private Limited ("Amazon") has used reasonable endeavours in compiling the information provided, Amazon provides no assurance as to its accuracy, completeness or usefulness or that such information is error-free. In certain cases, the blog is provided by a third-party seller and is made available on an "as-is" basis. Amazon hereby disclaims any and all liability and assumes no responsibility whatsoever for consequences resulting from use of such information. Information provided may be changed or updated at any time, without any prior notice. You agree to use the information, at your own risk and expressly waive any and all claims, rights of action and/or remedies (under law or otherwise) that you may have against Amazon arising out of or in connection with the use of such information. Any copying, redistribution or republication of the information, or any portion thereof, without prior written consent of Amazon is strictly prohibited.

*Map not to scale. The map has been used for design and representational purpose only, it does not depict the geographical boundaries of the country. These do not conform to the external boundaries of India recognized by the Survey of India.