Prevalence of the use of Letters of Credits in Botswana

Onkemetse Monnatsie | Wednesday August 28, 2024 09:56

 

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According to OEC data, the country’s top exports by value are diamonds representing about 87% of the country’s exports. Diamond exports are mainly to Belgium, India, Israel and United Arab Emirates, and the terms of payment for diamonds are typically cash in advance between the trading parties. On the other hand, the country’s top imports by value are refined petroleum, delivery trucks, electricity, tanks, and armoured vehicles. For these top imports, South Africa is by far the largest trading partner with a share of 31% followed by other trading partners including Namibia at 4%, Belgium at 3% and India at 2%. Others including China, UAE and the USA are all 1% and under.

From a banker’s view, the most prominent and common methods of payment for trade between Botswana and its main trading partners are:

1. Open account trading ‘buy now, pay later’ and,

2. Advance payments ‘payment prior to shipping’

Other known payment methods including guarantees, documentary collections and documentary credits, commonly known as letters of credits (LCs) in all its types and variants (standby, red clause, confirmed, irrevocable, green clause etc) are known and used to facilitate imports of goods and services. LCs are used mostly to import from trading partners including China, Canada, USA and others that represent under five percent of total country imports. Trade with these partners is relatively low compared to trade with South Africa, therefore another potential contributing reasons why LCs may not be widely used for imports by most corporates in Botswana.

LCs are commonly used by firms that are segmented within the banking divisions of SME and mid-corporates. These entities mostly import specialised machinery, medical, chemical inputs and other equipment. The SMEs and mid corporates are mostly value chain entities of the large corporates, and they mostly import to serve the large corporates, and this effectively translates into less prevalence of LCs by most large corporates since they outsource importation to SMEs and mid corporates who in turn use LCs for imports to fulfil their procurement contracts.

Save for SOE corporates in Botswana, most large corporates in the country tend to be subsidiaries of global and South African outbound conglomerates, and thus benefit from their parental support for imports of their trading goods and services. These multinational subsidiaries are also supported by strong global treasury hubs. SOE corporates on one hand, inherit and benefit from the country’s strong sovereign rating and hence some level of bargaining power with trading partners that allows and accords them open account trading where they can pay on terms after goods have been shipped or delivered. This in effect means that they may see no reason to use letters of credits if they can be allowed to pay after receiving goods and services.

Another observation is that unlike most African countries, commodity traders are not as common in Botswana. In other commodity rich African countries there are traders in almost all sectors such as oil, gas, mining and metals, agriculture etc. These traders typically buy directly from refineries, farmers, miners and other producers then sell to the demand for such commodities at a margin. They typically do not own the commodities themselves but simply match supply to demand and earn a margin. Buying the right goods according to demand specifications is of critical importance to them to be able to move their products and be paid, this is why they leverage letters of credits to minimize most import risks in their procurement and sales.

One could argue that for the above reasons that letters of credits prevalence in Botswana is quite low especially by corporates, but the use of LCs is common amongst SMEs and mid corporates who may be procuring on behalf of large corporates. Notwithstanding all the reasons why LCs are not as widely used as they may need to be, a general recommendation to all corporates and businesses that import goods and services is to explore and consider utilising LCs to de-risk their imports.

A letter of credit (LC) by definition is a financial instrument issued by the buyer's bank undertaking to pay the supplier upon fulfilment or performance of the terms stated in the letter of credit. It is thus a conditional undertaking by a bank on behalf of a buyer that subject to the supplier shipping goods as per agreed specifications and terms, and providing documentary evidence, the bank will pay them. An exporter may therefore be motivated to be meticulous in supplying goods under an LC than if they have been paid in advance. An LC provides assurance to your potential supplier (s) that a buyer has secured the necessary liquidity for the trade/transaction they are about to get in.

Using an LC in your procurement is thus highly recommended to not only reduce delivery and supply risks, but also to ensure goods are received as per agreed specifications, right quality and quantities

*Monnaatsie is a corporate and trade finance banker with over 10 years experience in the banking industry. He currently works for Stanbic Bank Botswana in Corporate and Investment Banking division. Please note that this is an opinion commentary limited by only known publicly available information to the author at a point in time. In no event will the author be liable for any loss or damage including without limitation, indirect or consequential loss or damage, or any loss or damage whatsoever arising from loss of data or profits arising out of, or in connection with, the use of this information.