Letter Of Credit

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I have done an internship in a large bank in China several years ago and been dealing with Letter of Credit a little bit. We've learned that he firm named in a Letter of Credit as the firm to which the issuing bank is promising payment if the importer does not pay. It seems like the issuing bank is bearing some of the default risk but it actually not. Before an importer requires a L/C, a same amount will be frozen on its account for the future payment. The only cost for bank is the labor cost. It might take an employee days or weeks checking for discrepancies. Our book tells us that most discrepancies are inconsistent data but that's after a L/C is issued. Before that, tons of corrections have been made, and most of them are even spelling and grammar. Even though, the labor cost is far more less than the 0.5% or more commissions of total contract the issuing bank asks. So do you think a L/C is overpriced or not? Why?

L/C is perceived expensive because the costs linked to each transaction are visible, whereas the benefits are hidden, intangible.

L/C provides a guarantee of payment to the exporter. It waves the risk of non-payment, giving a definitve date for the receipt of the funds (useful in case of hedging strategies). Add to that the opportunity to receive the payment in advance of the due date (through non-recourse discounting og the receivable).

http://www.aibtradefinance.com/tf/CaseStudy_1.asp
There has been a recent trend of organizations bypassing letters

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