Letters of credit
Types of letter of credit
There are five commonly used types of letter of credit. Each has different features and some are more secure than others. Sometimes a letter of credit may combine two types, such as 'confirmed' and 'irrevocable'.
Common types of letters of credit
A revocable letter of credit is uncommon because it can be changed or cancelled by the bank that issued it at any time and for any reason.
An irrevocable letter of credit cannot be changed or cancelled unless everyone involved agrees. Irrevocable letters of credit provide more security than revocable ones.
A confirmed letter of credit is one to which a second bank, usually in the exporter's country adds its own undertaking that payment will be made. This is used when the exporter does not find the security of an unconfirmed credit sufficient due to issuing bank risk or political and/or economic risk associated with the importer's country.
An irrevocable and confirmed letter of credit has not only the commitment of the issuing bank but also a binding undertaking given by the confirming bank to pay when the documents are presented in accordance with the terms and conditions of the credit. So a confirmed letter of credit provides more security than an unconfirmed one.
An unconfirmed letter of credit is one which has not been guaranteed or confirmed by any bank other than the bank that opened it. The advising bank forwards the letter of credit to the beneficiary without responsibility or undertaking on its part but confirming authenticity.
A transferable letter of credit can be passed from one 'beneficiary' (person receiving payment) to others. They're commonly used when intermediaries are involved in a transaction.
Other types of letters of credit
|Standby||A standby letter of credit is an assurance from a bank that a buyer is able to pay a seller. The seller doesn't expect to have to draw on the letter of credit to get paid.|
|Revolving||A single revolving letter of credit can cover several transactions between the same buyer and seller.|
|Back-to-back||Back-to-back letters of credit may be used when an intermediary is involved but a transferable letter of credit is unsuitable.|