Types of Letter of Credit

Letters of credit are irrevocable undertaking issued by issuing bank on behalf of applicant to pay upon complied presentation in documentary form. 

There are different types of letter of credit, let's have a look on few which are being used in our day to day business.

Types of Letter of Credit

• Revocable Letter of Credit: Revocable letter of credit is a credit, which can be revoked, cancelled or amended by the issuing bank, without the notice of other parties which may be issuing bank,beneficiary or a confirming bank if any. Revocable LC’s are rarely used, from an exporter’s point of view, this type of LC is not a satisfactory one, In terms of UCP 600. All terms are credit are deemed to be irrevocable even if there is no indication to that effect, article 10 of UCP makes it clear that “ a credit can neither be amended nor cancelled without the agreement of the issuing bank, the confirming bank if any and the beneficiary. This types of credit are very risky and not used now a days.

• Irrevocable Letter of Credit: Irrevocable LC is an undertaking issued by the IB and can’t be cancelled or amended without the consent of the parties to the LC, particularly the beneficiary. From an exporter’s point of view this is more favourable. The irrevocable nature of the letter of credit has enabled building up an elaborate commercial system on the basis of irrevocable banker’s credit.

• Confirmed Letter of Credit: Confirmed LC is a LC to which another bank (other than IB) has added its confirmation to pay. Thus, there is a double security in such credit and it is more favourable to beneficiary, generally, the confirmation is desired by beneficiary from a bank known to him, preferably the one located in his country so that his risk becomes localized and he can deal easily with a local bank rather than deal with a bank abroad, which has issued the credit. But this type of LC is costlier to the parties concerned, since there would be charges of confirming bank. It covers the Credit Risk and country risk for the beneficiary other than issuing bank.

• Sight and Usance Credit: Sight LC states that the payment would be made by the issuing bank at sight basis, on demand or on presentation of complying documents. In case of usance credit, drafts are drawn on the IB or the nominated bank at specified usance period.

• Back to Back LC: It is also called as countervailing LC, when an LC is opened against the security of another LC and with corresponding terms, the credit thus opened is termed as Back to Back LC, the original credit which is offered as security for opening a B2B credit is called as principal credit and other one is called is Baby Credit.

Need for such credits arise mainly when:

a. Ultimate buyer is not prepared to open a transferable credit.

b. The beneficiary is not willing to disclose or divulge the source of supply to the openers.

c. Actual manufacturers insist on payment against documents for goods but the beneficiary is short of funds.

From a banker point of view, a B2B credit is not as safe as a transferable LC, because payment has to be made against documents received under the B2B but the issuer of the B2B LC may not be able to submit the same documents under original LC to obtain reimbursement.

• Standby Letter of Credit: These credit are generally used as substitute for performance guarantee or for securing secured loans. The document generally called for under such credit is a simple statement of claim or proof of delivery of goods or certificate of non-performance.

This type of LC is issued mostly by banks in countries where the law prohibits them from issuing guarantees. Even though SBLC is a substitute for guarantee, it has developed as an all-purpose financial support instrument embracing wider range of uses than normal demand guarantee and is issued to cover situation of non-performance.

• Revolving LC: Is a LC which revolves, in terms of time or value, it is generally issued when an applicant and beneficiary have a long standing repetitive trade relationship.

This can be segregated in below parts:

a. Automatic: if the revolvement are automatic there is no need for any further amendments by issuing bank.

b. Non Automatic: if it is non automatic if dependent upon issuing bank’s authorization for further revolvement.

c. Cumulative : The LC may indicate that the revolvement is on a cumulative basis, for example if USD 25000 can be drawn each month during a LC’s six month validity, any amount not used in a  month remains available for drawing in the following month. Therefore, in the sixth month, the LC could be available for the cumulative total of USD 150000.00 if no previous drawings made.

d. Non-Cumulative : as per above same example if one month’s shipment of USD 25000.00 were not made then the unused amount will not be carry forward to succeeding month, for example if not shipments  had been made for five months then the maximum drawing amount for the sixth month will be USD 25000.00 only.

• Reinstatement LC:  An LC having a reinstatement clause is used when the applicant wishes to control the amount of the goods that are shipped in any one shipment, but the bene considers the conditions of article 32 of UCP 600 unacceptable of the risk of the LC ceasing to be available for that or any subsequent instalment, should it not keep to the designated schedule of shipments.

• Red Clause LC: A letter of credit which contains a clause (traditionally printed in red) authorising the nominated bank to make advances to the seller before shipment/presentation of documents.

• Green Clause LC: Similar to a red clause LC, a green clause LC is a variation on the traditional LC that allows a nominating bank to make an advance payment to the exporter for also warehousing, Experts often consider green clause LCs to be an extension of red clause LCs.

• Evergreen LC: An evergreen LC is kind of credit which contains a clause for auto extension and does not expire.

There could be more types of LC's depends on the need of beneficiaries and applicant, such as mixed payment terms LC, where in if partial shipments are there then the part of the payment may be on sight terms and other may be on usance terms etc.