Letter of Credit and its types | Texhour

Letter of credit:

L/C is the payment method commonly used in all international trade. A Letter of Credit is an arrangement whereby Bank acting at the request of a customer (Importer / Buyer), undertakes to pay for the goods/services, to a third party (Exporter / Beneficiary) by a given date, on documents being presented in compliance with the conditions laid down. It is also known as Documentary Credits.

Parties to the letter of credit:

1. Opener:

The opener is the buyer whose behalf the credit is issued.

2. The Issuer:

L/C is issued by the bank after the request of the buyer/importer. Issuing bank or financial institution that provides the L/C is called Issuer.

3. The beneficiary:

The credit is issued in favor of the beneficiary party and the beneficiary is seller or exporter.

4. The Conforming bank:

The conforming bank which adds its guarantee to the LC opened by another Bank and thereby undertakes all responsibility for payment or acceptance or negotiation under the credit in addition to that of the Issuing Bank. It is a bank operating in the exporter’s country and it guarantees the credit at the request of the issuing bank. If L/C is confirmed, the conforming bank has to inform the exporter.

5. The Advising bank:

 At the request of issuing bank, the advising bank informs or notifies the exporter that their credit has been opened. If L/C is confirmed, the conforming bank has to inform the exporter.

6. Nominated bank:

A bank in the beneficiary country is the nominate bank where the credit is available within the letter of credit.

Types of L/C:

1. Revocable letter of credit

2. Irrevocable letter of credit

3. Transferable letter of credit

4. Un-Transferable letter of credit

5. Standby letter of credit

6. Payment letter of credit

7. Confirmed letter of credit

8. Unconfirmed letter of credit

9. Back to back letter of credit

10. Red clause letter of credit

11. Revolving letter of credit.

1. Revocable letter of credit:

A revocable letter of credit is one which can be canceled or amended by the issuing bank at any time and without any prior notice to the beneficiary. The exporter considered this letter of credit as not safe.

2. Irrevocable letter of credit:

An irrevocable letter of credit is one which cannot be canceled by the issuing bank at any time and without any prior notice to the beneficiary or exporter.

3. Transferable letter of credit:

A Transferable Credit is one that can be transferred by the original beneficiary to another beneficiary within given period for shipment or before the expiry date.

4. Un-Transferable letter of credit:

A Un-Transferable Credit is one that cannot be transferred by the original beneficiary to another beneficiary.

5. Standby letter of credit:

This type of L/C is opened by the issuing bank agreed that they pay to the seller on behalf of the buyer, the draft must be followed by the documents specified in the L/C. This is considered as safest to both importer & exporter and also known as documentary L/C.

6. Payment letter of credit:

It is a sight credit which is available for payment at sight basis against presentation of requisite documents to the issuing bank. In a payment letter of credit, beneficiary may or may not be called upon to draw a bill of exchange.

7. Confirmed letter of credit:

The confirmed letter of credit is confirmed once the advising bank adds its agreement to the issuing bank. This can secure the payment from local bank.

8. Unconfirmed letter of credit:

It is guaranteed or agreed by issuing bank not by advising bank. This type of L/C is most common in use and therefore little risk in payment.

9. Back to back letter of credit:

In back to back L/C the middleman or agents play an important role where buyer issue first L/C in favor of agent and second L/C is opened for the beneficiary by the agent. Although it contains two independent L/C so it rarely practiced in international trade.

10. Red clause letter of credit:

The nominated bank provides the pre-shipment credit to the beneficiary or exporter as per the authority is given by the issuing Bank. In case the beneficiary fails to export the goods or fails to repay the advance the nominated bank gets the amount paid by the issuing bank. Though it is printed in red, it is called as red clause L/C.

11. Revolving letter of credit:

If both the buyer and exporter doing the regular business transaction they may use revolving L/C to prevent opening of new L/C for each shipment.