Why a letter of credit is not used in domestic trade in Bangladesh?

Yarab A | Updated on: March 28, 2023

A letter of credit, while a key cog in international trade, is not needed for domestic trade in Bangladesh. Here, we will tell you why. But before we get into the details, it is important that we understand the differences between international and domestic trade. Let us first get into what international and domestic trade is

International Trade

In international trade, goods or services are exchanged between two or more nations. These may be via land, sea, or air, although shipping constitutes the largest element. These days, supply chains are so advanced that for a car that is made in one country, parts may originate from more than fifty different countries. So, without international trade, you probably would not have Colombian coffee or Japanese cars at home. International trade results in cheaper, more competitive products being available to the consumer.

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Domestic trade

Trade of goods and services that occurs within the boundaries of a country, within its jurisdiction, is considered to be domestic trade. Usually, we are familiar with this in the form of wholesale or retail. In domestic trade, the objects being traded are sourced locally - but not necessarily within the sub-unit of the country, it is in. For example, a saree being sold in Dhaka may have been made from silk in Chittagong, or vice versa. Domestic trade has the ease of being conducted in the same currency and often without language barriers.

Differences between international business and domestic business

The differences are fairly straightforward, the primary one being that the economic activity is done within a nation’s borders. International business also brings in added risks, but maybe greater rewards. For example, there is the currency exchange rate to be considered, the quality demanded may be higher, and the volume of trade will almost surely be larger considering the entire world is a possible target.

Reason for using letter of credit in international trade

The usage of Letter of Credit in international trade presents obvious advantages: for sellers, it guarantees payment. For buyers, it gives them access to cheaper goods as well as saving the hassle of establishing their credentials to a foreign entity. The backing of a bank helps smoothen the process.

Reason for not using L/C in somestic trade

In domestic trade, both buyer and seller are bound by the laws of their home country and are fully aware of the implications of their not keeping to the contracts. Besides this is the added factor of geographical and legal proximity in domestic business. In international trade, it is often difficult and near impossible to navigate laws of other countries, not to mention the sheer geographical distance. Hence, a letter of credit makes international trade safer and comfortable. However, since the barriers to domestic trade are far less - currency, language, legal, and distance wise - a letter of credit simply adds to the often-cumbersome trade process. A letter of credit may simply add one more unnecessary layer while not really providing the sort of safety net necessary in domestic trade.

An example of letter of credit

Assume that a car company Bangla Motors in Dhaka wants to import $1 million worth of aluminium sheets from India Sheets, Kolkata. However, India Sheets is probably unaware of who Bangla Motors are, and are unsure if they will be able to pay the amount upon delivery. Bangla Motors then approaches a bank in Bangladesh, who are happy to provide a letter of credit with a guarantee that the million dollars will be paid to India Sheets. India Sheets will approach their bank and confirm that the shipment has been made (with proof), and their bank will convey this to the Dhaka bank. This ensures that India Sheets get paid, and Bangla Motors get their sheets.

In conclusion, it is evident that a letter of credit is required primarily only for international trade. While it is necessary and a requisite at the international level, it merely adds an unnecessary burden during domestic trade, and can be safely avoided.

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