Problem on rules of the International Chamber of Commerce

Question

RainFlower Trading Limited is a wholesaler of electronic calculators in Hong Kong. It has been importing goods from a Philippine manufacturer for eight years. The Philippine manufacturer had accepted payments in advance in the past. Recently, because of political turmoil in the Philippines, RainFlower Trading Limited considered that the current trade arrangement was too risky. On the other hand, the Philippine manufacturer would not accept payments on open account and requested to have payment in some form of undertaking by a bank. The manager of RainFlower Trading Limited approaches your bank for help. You are required to:

a) Suggest a method of payment that your bank could assist RainFlower Trading Limited with. Please point out the advantages and disadvantages of your suggestion to the company.

b) Discuss the roles and responsibilities of your bank in the method suggested in part under the relevant rules of the International Chamber of Commerce.

Answer 1

a) The bank can issue a letter of credit to RainFlower Trading Limited. Instead of facing the Philippine manufacturer as the counterparty, the company has their receivables faced to the bank as the counterparty. As a result, the credit risk of the counterparty is reduced for the company and therefore it is more confident for the company to expand their business as their cash flow risk is reduced. However, there is no free lunch for the bank to serve as an intermediary. A hair cut charge will be imposed by the bank on the receivables. Therefore, the profit margin of the company will be reduced with the fee charged by the bank.

b) The roles of banks in the letter of credit include the issuance of the letter of credit

The issuing bank holds primary responsibility for the payment of funds. If the business transaction is canceled, the issuing bank deducts LC fees and expenses, and releases the remaining security deposit. The issuing bank has the obligation to nominate another bank as the nominate bank to act on behalf of all LC transactions.