What is the difference between documentary collection and letter of credit? What are the risks associated with documentary collection and letter of credit? Why an exporter or importer would prefer one over another?

Answer:

LC (Letter of Credit):

A letter of credit is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. This means, if you do not perform your obligations, your bank pays.

Due to the nature of international dealings, including factors such as distance, differing laws in each country, and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade.

LoU (Letter of Undertaking) - General meaning:

A letter of undertaking is an agreement or contract between 2 parties that outlines specific work activities being completed in a certain time frame. In this case work activities would refer to handing over certain documents or money (payment) to the Bank/ Institution / Organisation in a certain time frame.

Difference between LC and LoU:

The LoU is useful to give undertaking in banks/ financial institutions/ organisations. However, LC offers facility to trade partners to transact with unknown partners or in newly established trade relationships. It helps in expanding their business quickly into new geographies. Both are different instruments.