Usance Letters of Credit in International Trade

Core Description

• Usance functions as a deferred payment mechanism in trade finance, offering buyers time to pay after goods are shipped and documents are accepted.
• It optimizes working capital for buyers and provides security for sellers, but introduces specific risks, costs, and compliance obligations.
• Effective use of usance demands careful structure, risk mitigation, and alignment with transaction cash flows.

Definition and Background

Usance, also known as a deferred payment term, is a widely adopted financing tool in international trade. Under a usance arrangement, the buyer is allowed to pay for goods at a specified future date—typically 30, 60, 90, or even 180 days after shipment or after presentation and acceptance of shipping documents. This payment extension is commonly formalized through a usance letter of credit (LC), a time draft, or similar trade instruments.

Historically, usance evolved in medieval Europe as merchants needed to bridge both geographical distance and the time required for transportation. By the Renaissance, bills of exchange with standardized usance periods facilitated commercial dealings between major trading centers. During the industrialization and globalization periods of the 19th and 20th centuries, usance terms became foundational in cross-border finance, supporting the movement of capital goods, commodities, and durable products.

Today, usance is integral in global trade. Its application ensures sellers receive additional assurance of payment (through a third-party bank undertaking), while buyers benefit from liquidity management and working capital flexibility. Usance’s prevalence is supported by the International Chamber of Commerce rules (notably UCP 600), establishing a standard legal and operational framework for banks, traders, and intermediaries.

Calculation Methods and Applications

Determining Tenor and Base Date

The usance term, or "tenor," defines the deferred period before payment is due. Tenor typically begins from:

• Bill of lading (B/L) date
• Shipment date
• Date of document presentation ("after sight")
• Invoice date

The base date and calculation method must be precisely specified in the LC or sales contract to ensure clarity on payment schedules.

Example Calculation

Suppose a usance LC specifies “60 days after B/L date.” If the B/L is dated March 10, 2025, maturity would be May 9, 2025, unless otherwise adjusted for weekends or holidays by applicable banking conventions.

Accrued Interest and Fees

Usance payments include financing costs, which may consist of:

• Issuing/confirmation fees
• Acceptance commissions
• Discount interest (if the seller seeks early payment by discounting at a bank)

The annualized financing cost is calculated as:

Total Interest = Principal × Interest Rate × (Tenor in Days / 360 or 365)

For sellers, early funding is achieved by selling (discounting) the accepted draft to a bank at a discount rate that reflects the time value of money and associated risks.

Worked Example

Scenario: An exporter agrees to a usance LC with a face value of USD 200,000, 90 days after shipment, at a 5 percent annual interest rate.

Simple interest for 90 days:
Interest = USD 200,000 × 5% × (90 / 360) = USD 2,500

If bank charges for discounting are 0.2 percent (USD 400), net proceeds = USD 200,000 - USD 2,500 - USD 400 = USD 197,100 (if the seller requires funds immediately after document acceptance).

Applications in Trade

Usance is commonly applied in transactions involving capital goods, machinery, and commodities with predictable resale cycles. For example:

• Machinery producers in Germany offering 90–180 day terms to buyers in Latin America
• Coffee exporters structuring 60–90 day LCs to align with shipping times and local inventory turnover

In such cases, usance smooths working capital for both exporter and importer, while mitigating open account risks.

Comparison, Advantages, and Common Misconceptions

Usance vs. Other Trade Instruments

Advantages for Buyers

• Deferred cash outflow aligns payments with sales receipts.
• Enables negotiation for higher order volumes or competitive pricing.
• Eases foreign exchange (FX) management, as buyers may secure currency over a longer period.

Advantages for Sellers

• Bank payment assurance on compliant documents reduces non-payment risk.
• The opportunity to discount drafts or receivables for early cash enhances liquidity.
• Supports entry into new markets with better risk management.

Disadvantages for Buyers

• Total costs may be higher due to added fees and interest.
• Sometimes stricter covenants and documentation requirements.
• FX and commodity price volatility risks between shipment and payment.

Disadvantages for Sellers

• Delayed cash inflow unless the draft is discounted, potentially reducing margin.
• Potential for non-payment if documents are discrepant.
• Exposure to bank and country risk if not confirmed by a reputable bank.

Common Misconceptions

Mistaking usance for open account terms:
A usance LC is a bank-mediated documentary credit, not an unsecured promise by a buyer.

Assuming banks always pay:
Banks honor usance LCs strictly based on documentary compliance. Errors or delays in documents can result in suspended payment.

Overlooking FX risk:
Long tenors increase currency exposure. Proactive hedging may be necessary.

Ignoring cost implications:
All costs (interest, fees, discounting) should be considered in pricing; overlooking them can affect profit margins.

Practical Guide

Risk and Suitability Assessment

Before choosing usance, assess:

• Buyer creditworthiness and transaction history
• Country risk and currency restrictions
• Bank and counterparty reliability (consider confirmation to reduce risk)
• Transaction size in relation to the willingness to absorb fixed costs

Structuring Usance LCs

• Specify documentary requirements clearly.
• Select issuing, advising, and, if needed, confirming banks with strong reputations and sector expertise.
• Align tenor with commercial needs, transit time, and inventory cycle.

Efficient Document Management

• Pre-check all documents against LC terms to avoid discrepancies.
• Use standardized templates for invoices, bills of lading, and insurance.
• Allow additional time for document presentation and corrections.

Managing Costs and Hedging Risks

• Clarify allocation of all charges in the LC (applicant, beneficiary, outside banks) through negotiation.
• Consider bank discounting or forfaiting for early payment if required.
• Lock in exchange rates using forwards or options for FX exposure.

Sample Case Study (Fictional, Not Investment Advice)

A Spanish machinery exporter sells packaging equipment valued at USD 500,000 to a Brazilian food manufacturer under a 120-day usance LC. The exporter submits shipping documents to its local bank, which checks compliance and seeks confirmation from a global bank. The Brazilian buyer pays at maturity, but the exporter chooses to discount the accepted draft 10 days after shipping at 4.5 percent per annum, incurring a cost of USD 7,400 (interest and fees). This enables the exporter to pay suppliers and start new production cycles. This example is for illustrative purposes only and does not constitute investment advice.

Resources for Learning and Improvement

• Textbooks: Jack, Documentary Credits (Informa); Ellinger & Neo, The Law and Practice of Documentary Letters of Credit (Hart).
• ICC Publications: UCP 600, ISBP 745, eUCP 2.1; ICC Opinions for real-world interpretations.
• Regulatory Guidance: Basel Committee on Banking Supervision (BIS); WTO and UNCITRAL papers on trade finance.
• Industry Bodies: ICC Banking Commission, BAFT, ITFA (trade finance model forms, webinars, and risk guidance).
• Courses: ICC Academy Global Trade Certificate; LIBF’s CDCS/CSDG certifications; relevant MOOCs on edX and Coursera.
• Journals: Journal of International Banking Law and Regulation, Uniform Law Review.
• Data Sources: ICC Trade Register for risk benchmarks; WTO, IMF for sector-level trade data.

FAQs

What is a usance letter of credit?

A usance LC is a trade finance instrument allowing payment at a fixed future date after the presentation of compliant shipment documents. It gives the buyer time to pay after shipment while providing the seller with bank-backed assurance.

How is usance different from a sight LC?

Sight LCs pay the exporter immediately upon compliant document presentation, while usance LCs defer payment (for example, 30–180 days), supporting buyer liquidity with additional fees and interest.

Who pays for the interest and fees under a usance arrangement?

Responsibility depends on contract terms—costs may be included in the goods price or charged separately. The party seeking discounting pays the applicable bank’s rate.

What risks are associated with usance LCs?

Key risks include buyer default, documentary discrepancies, issuing bank or country risk, FX fluctuations, and delayed shipment or non-compliance. Bank confirmation, insurance, and hedging can help mitigate these risks.

How are typical usance periods determined?

Tenors often reflect the product’s shipping time, buyer’s working capital cycle, and market norms—commonly 30, 60, 90, or 180 days.

What documents are required for a usance LC?

Typical requirements include commercial invoice, bill of lading or air waybill, insurance certificate, packing list, certificate of origin, and relevant inspection certificates.

Can the seller obtain early cash under a usance LC?

Yes, by discounting the accepted time draft with a bank or through forfaiting, converting the receivable into cash minus the applicable interest and bank fees.

What rules and standards govern usance LCs?

The ICC’s UCP 600 is the main global standard, with supplemental local laws and conventions such as Incoterms and URC 522 for collections.

Conclusion

Usance is a key structure in modern trade finance, providing payment terms that address the cash flow needs of buyers and the security requirements of sellers. Usance is not costless or risk-free—effective use requires careful contract design, documentation, and risk management. When appropriately used, usance LCs can support new market opportunities, streamline cross-border transactions, and promote long-term relationships in international trade. Whether you are an experienced finance professional or new to export-import operations, understanding the mechanics and strategic uses of usance can support global trading decisions and strengthen treasury strategies.