An inland letter of credit is exactly like a regular letter of credit. The only difference between the two is that a regular letter of credit is used for international transactions, whereas the inland letter of credit is used for domestic transactions. Consequently, we can say that this letter of credit is a payment instrument used to facilitate domestic trade.
Why Inland Letter of Credit?
If we understand the common usage of the letter of credit, we can understand that a letter of credit is used to mitigate risk related to international trade. The bank becomes the intermediate between the buyer and the seller to ensure a smooth and risk-free transaction. Some may wonder why a letter of credit is designed specifically for domestic trade transactions?
The answer lies in the type of risks associated with domestic transactions. If we take a closer look at the risks in the domestic transaction, we will understand that a lot of risks that are present in the international trade are also in the domestic trade. Let’s understand this further –
Risks in Domestic Trade
- Risk of Non-Payment
A major risk associated with any transaction, regardless of its geography, is the risk of non-payment. In simpler terms, the seller will be afraid that he will not receive the payment for his supply. With this letter of credit, this risk is hedged as the letter of credit issuing bank promises to pay if the terms of the letter of credit are met.
- Risk of Delayed Payment
Also, any transaction carries an inherent risk of delayed payment, which means a possibility that the seller may not get his payment on time. When this letter of credit is used as a payment instrument, the seller has the security that he will receive timely payment. This way, he can manage his working capital better.
- Risk of Unfulfilled Obligation
Sometimes in a domestic transaction, the buyer and the seller lack trust and may feel that the opposite party will not fulfill their obligation. In such cases, an inland letter of credit comes in very handy. The beauty of this payment instrument is that it ensures that both parties fulfill their obligations.
This discussion helps us understand that a letter of credit can be as useful in a domestic transaction as in an international one.
Types of Inland Letter of Credit
An inland letter of credit is different from any other type of letter of credit. In a way, it is customizable as per the needs of the transaction of the parties. An inland letter of credit can be –
- Inland letter of credit – Usance – In this, the domestic buyer can avail of a credit period on his purchase.
- Sight – Inland letter of credit – In this, the seller receives the payment as soon as the required documents are submitted
- Inland letter of credit – Mixed Payment – The payment terms are customizable.
Finally, it is important to note that even though the inland letter of credit looks useful on paper, it is not very widely used in practicality. Multiple reasons contribute to this reality. The reasons include growth in alternate banking products such as bank guarantees, bill discounting, etc. Also, the rise of the internet has promoted transparency. It has become much easier for business houses to assess their clients and vendors, thereby increasing trust. These factors have made this letter of credit quite obsolete.