Practical measures for preventing and managing fraud risk in letter of credit

In today's business, the most important and common method of international payment is documentary credit or L/C which is widely used by traders and commercial companies as a tool for financing and payment in international transactions. One of the purposes of documentary credit as a method of payment in international commercial transactions is to facilitate the process of international trade. However, due to its special features such as reliance on documents, spatial distance between buyer and seller, lack of efficient legal prosecution mechanisms and differences in the approach of legal systems at the international level, it can increase the risk of fraud in international payments. Although in most cases the L/C applicant (buyer) has been abused as the main victim of fraud, it can generally be said that all those involved in L/C may be victims of fraud. Despite the fact that so far in most cases, the L/C applicant (buyer) has been abused as the main victim of fraud, but the expansion of new methods of fraud in L/C has led to an increase in cases in which the beneficiaries, insurance companies and involved banks have also been deceived. Therefore, the issue of fraud and its prevention methods is very important for all those involved in documentary credits.

Given that traditional methods of dealing with fraud in documentary credits such as civil remedies and criminal penalties are not effective in combating fraud, in this paper, risk management mechanisms with focus on a preventive approach to minimize the risk of fraud in documentary credits and necessary and possible measures may be taken to avoid those frauds that may actually occur in the process of preparing and submitting documents, are considered. Our research is based on the hypothesis that by taking the practical measures mentioned in this research by those involved in the process of payment through L/C, the risk of fraud will be minimized and this approach is more effective than other countermeasures against fraud, such as legal or criminal litigation against a fraudster.

The method for collecting information is a library method. We studied statutes, regulations, cases as well as articles and books about this topic. In this comparative study, the method of thinking is the descriptive-analytical method.

Although fraud is one of the oldest and most well-known phenomena in the business world, it is very difficult to detect and manage. In practice, an important fraud may never occur, but efficient risk management can keep the business one step away from fraudsters. Due to the irreparable damage that the issue of fraud can cause, it is necessary for every company to have an effective system for prevention, detection and response to fraud. In particular, the following are the key points for the company's success in developing a counter-fraud system: The first is to take advantage of a proper internal organizational charter and adopt a proper anti-fraud policy. The second is to train the company's employees in the direction of awareness and care towards identifying the symptoms of fraud or the possibility of its occurrence, and the third is to eliminate the effective problems in the occurrence of fraud and ensure their elimination. Therefore, an appropriate anti-fraud policy should include four measures on its agenda: prevention, identification and detection, deterrence, and ultimately appropriate response to fraud. To counter fraud, prevention and deterrence must go hand in hand. Therefore, when drawing up a counter-fraud trend or mechanism, the business should consider both. However, even the most extreme controls may not be effective against professional fraudsters, so a proper enforcement program is needed to detect fraud. Once the fraud has been identified and discovered, it is necessary to respond appropriately. Therefore, in order to manage the risk of fraud, in particular, it is necessary to take preventive measures before the actual occurrence of fraud, in order to control and prevent its harmful consequences. All those involved in documentary credit, in turn, can play a role in preventing fraud in the process of payment by documentary credit by taking a risk management approach and taking precautionary measures against fraud. The buyer's preventive measures as the main victim of fraud include: checking the seller's credit, checking the capacity and location of the contractual vehicle, using an independent inspector, using the usance draft, Including the condition of "purchasing after the approval of the goods", confirming the authenticity of the bill of lading, requiring the carrier to send the bill of lading to the bank, using the  performance guarantee, obtaining insurance policy and export credit insurance and finally requesting electronic submission of documents. On the other hand, the seller can minimize the risk of fraud by selecting a reputable customer, carefully reviewing L/C provisions before accepting them, carefully arranging the main sale contract, and improving intra-organizational relationships and cooperation with banks. The steps that banks must take to prevent fraud in documentary credits include: providing extraordinary services, doing extraordinary checks in the likelihood of fraud, caution in daily activities and use of the services of the International Chamber of Commerce. Finally, lawyers and legal advisers of the parties involved in documentary credits should also have the necessary skills and strategies to adopt a preventive and proactive approach in providing advice to their clients and arranging contracts and managing contractual risks.

Fraud can impose irreparable costs on a trader or business, so it is important to keep the risk of fraud at the center of the risk management system of commercial companies and the same is true of L/C risk fraud management. There are a number of reasons for fraud in L/C, most of which include the payment of L/C by the bank in exchange for merely presenting documents that appear to comply with L/C requirements, the geographical distance between the LC applicant and the beneficiary and the lack of an internationally accepted legal framework for fraud prevention. Therefore, it is necessary that all parties involved in L/C, including the applicant and the beneficiary, banks involved in L/C and legal advisers of the parties, in turn, prevent and minimize the possibility of fraud in international transactions involving L/C by taking preventive and deterrent measures. However, identifying preventive methods and measures using legal solutions to prevent any fraud and misuse of documentary credits is an important issue that in international business management, its importance and necessity is undeniable. Since Iranian law does not provide for rules on documentary credits and countering fraud, Iranian banks comply with UCP regulations under the Monetary and Credit Council enactment and these regulations also do not address the issue of fraud in documentary credit, so it seems necessary for the central bank to establish special regulations and to develop guidelines in this regard.