Problems with the System & Transaction Frauds

Based on the previous discussions it can be gathered that the main weakness of the letter of credit system is that fraudulent behaviour coming from the buyer and the seller is overlooked. The system apparently does not have room for inspection should scrupulous actions take place, and in the end, the issued letter of credit, which acts as the main receipt of the transaction, seems to exist in a bubble of protection. Although it is undeniable that it is important to create options of instant and hassle-free trade transactions, the problem with this system is that it can be subject to abuse.

Similar to the sub-prime lending issue in the United States, the system focused more on the business side and overlooked the fact that the system has loopholes for those who can take advantage of the system. Hence, in the processes of the letters of credit, the major problem is that the buyers and the sellers are expected to behave based on an honour system as spelled out in the underlying principles of credit. Although this has worked, the mechanisms of this credit system have yet to create enough venues for fraud prevention.

What makes this unfortunate is that as the facilitating tool of the sales transactions, there is not enough governance and provision for protection for buyers and sellers. There has been more reliance on the “know your client” policy and the principles of credit thus further burdening the sellers and the buyers with the risks. With the amount of fraudulent activities that has been taking place, it is evident that the system needs to be modified. Banks should be therefore redefined in terms of their roles in this system.

The issuing bank can further extend its services to its client, the buyer, by means of conducting an investigation or an examination of the goods declared that are going to be shipped by the seller. This is an obligation that a bank can provide since the issuing bank initially paid for these goods, and in the end, the buyer would be paying the bank back, along with additional fees, for the services rendered. Another way to resolve this problem is to have an additional body that can actually conduct these investigations; this body can work at the port and can check the goods before they get shipped to the buyer.

Hence, the liability can then be redirected to this entity instead of creating problems for all parties and victims involved should actual sales and transaction frauds take place. Such solutions can be a means to make the letter of credit system more competitive and effective. More and more businesses will be attracted to using this tool because of the guarantee of payment and security, and at the same time, the fear for fraudulent scenarios will be addressed and eradicated.

Such solution can be also worked with international trading bodies as basically, protection for buyers and sellers is a basic trading right. Trade can be facilitated more if the businesses have enough confidence that the transactions they are about to get into assure them with sufficient security and protection along with the guarantee of convenience in transaction as basically provided by the letter of credit system.

References Baker, J. (2003). Financing International Trade. Westport, CT: Praeger. Blodgett, M. Wilson, J.(1993). The Impact of Transaction Fraud: Strategies for the International Letter of Credit. Review of Business, 14, 42+. Cranston, R. (1997). Principles of Banking Law. Oxford: Clarendon Press. Credit Research Foundation. (1999). Understanding and Using Letters of Credit. Retrieved 30 April 2009 from http://www. crfonline. org/orc/cro/cro-9-1. html Hong Kong Industrialist. (2008). Letter of Credit Fraud and Money Laundering. Retrieved 1 May 2009 from www. industryhk. org/english/fp/fp_hki/files/HKI09_LC_fraud_e. pdf