Types of Letter of Credit

types of letter of credit

Introduction

There are several types of letters of credit (LC) that can be used in international trade transactions. The choice of the type of LC depends on the agreement between the buyer and the seller, as well as the specific needs of the transaction.

Here are some common types of letters of credit:

1-Irrevocable Letter of Credit:

An irrevocable LC cannot be amended or canceled without the consent of all parties involved. It provides a higher level of security for the seller.

2-Revocable Letter of Credit:

A revocable LC can be amended or canceled by the issuing bank without prior notice to the beneficiary (seller). However, revocable LCs are rarely used in international trade due to the lack of security for the seller.

3-Confirmed Letter of Credit:

In a confirmed LC, a second bank (the confirming bank) adds its confirmation to the credit, undertaking to honor the credit's terms. This provides an additional layer of security for the seller.

4-Unconfirmed Letter of Credit:

An unconfirmed LC is only backed by the issuing bank's commitment. The seller relies solely on the creditworthiness of the issuing bank.

5-Sight Letter of Credit:

In a sight LC, payment is made immediately upon presentation of conforming documents. The seller is paid as soon as the required documents are submitted.

6-Time or Usance Letter of Credit:

In a time or usance LC, payment is deferred and is made at a later date specified in the credit. This allows the buyer time to inspect the goods before making payment.

7-Standby Letter of Credit:

A standby LC is not intended for payment against documents but is used as a form of financial guarantee. It is often used in situations where the buyer may default on payment or fail to fulfill contractual obligations.

8-Transferable Letter of Credit:

A transferable LC allows the beneficiary (first beneficiary) to transfer all or part of the credit to one or more secondary beneficiaries. This is useful in cases where an intermediary is involved in the transaction.

9-Back-to-Back Letter of Credit:

In a back-to-back LC, an intermediary uses the original LC received from the buyer to issue a second LC in favor of the supplier. This is common in situations where a middleman is involved in the transaction.

10-Red Clause Letter of Credit:

A red clause LC includes a special clause that allows the advising/negotiating bank to make partial payments to the seller before the shipment of goods. This can be beneficial for the seller to finance the production process.

11-Green Clause Letter of Credit:

Similar to the red clause, a green clause LC allows for partial payments to the seller but, in addition, permits warehousing of the goods before shipment.

Conlusion

These are general categories, and variations can exist based on the specific terms agreed upon by the parties involved in the trade transaction. It's important for both buyers and sellers to clearly understand the terms and conditions of the chosen type of LC before entering into any international trade agreement. Additionally, seeking advice from financial and legal professionals is recommended to ensure compliance with international trade regulations.