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Africa Economic Brief - Trade Finance in Africa: Letters of Credit
Trade finance is critical for the facilitation of international trade by overcoming the challenges of information asymmetry, contract enforcement and liquidity issues inherent in cross-border transactions. A key instrument used by banks in trade finance is the letter of credit. In a typical cross-border trade operation involving bank intermediation, an importer (buyer) would request a bank2 to issue a letter of credit which would represent its obligation to pay the exporter (seller3) provided the terms of the contract are fulfilled. Hence, the letter of credit provides a guarantee to the exporter (seller) that the payment for the goods or services he provided will be made since an established financial institution is not expected to default on a payment.