Difference between Letter of Credit and Drafts

Difference between two payments methods of international trade – Letter of credit and Drafts are given below:

Letter of Credit Drafts
Bank issues Letter of Credit on behalf of the importer assuring payment to the exporter upon presentation of the shipping documents to the bank. Draft or Bill of Exchange is drawn by the exporter instructing the importer to pay face value of the draft on sight or at certain time in future.
If the documents are in compliance with the terms of LC, Bank is liable to pay the seller/exporter regardless of the buyer’s ability or willingness to pay. Banks act as intermediaries in processing the documents and the collection of payment for the exporter.
Importer’s bank is obligated to make payment to the exporter on behalf of importer if presented documents are fully complied with the terms of LC. Importer has three options after examining the documents:
To pay immediately in case of Sight draft
To pay at future date in case of Time draft
Or to refuse to pay the draft
Payment is made to the exporter only when shipment is made. Sight draft:
Payment is made on presentation of the draft to the importer.
Time draft:
Payment is made by the importer on maturity of the draft.
Goods will be available to the buyer after payment. Sight draft:
Goods available to the importer after payment.
Time draft:
Goods available to the importer before payment.
In case of LC exporter has to face risk very little or none depending on the terms conditions & of LC. Sight draft:
If draft is unpaid, goods will have to dispose of.
Time draft:
Exporter relies fully on buyer to pay draft at maturity.
Importer is assured that shipment is made. Sight draft:
It is assured that shipment is made.
Time draft:
It is assured that shipment is made.
Importer fully relies on exporter to ship goods as described in documents. Because bank doesn’t deal in goods. Sight Draft:
Importer fully relies on exporter to ship goods as described in documents. Importer might have an option to inspect goods before payment.
Time draft:
Relies on exporter to ship goods as described in documents. Importer might have an option to inspect goods before payment.
LC costs more to the importer. Drafts are less expensive for the importer.
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