Types of Letter of Credit

Types of Letter of Credit

Letter of credit
In international trade there is a lack of trust and believe among buyers and sellers.
Letters of credit are used to allow the facilitation of trade between buyers and sellers of goods worldwide. In order to facilitate trade, letters of credit are put in place by the buyer and seller.
Letters of credit are used to allow the facilitation of trade between buyers and sellers of goods worldwide. In order to facilitate trade, letters of credit are put in place by the buyer and seller.
LC is issued against collateral. Bank charges a fee for issuing letter of credit, it is the fundamental concept of international trade and is guided by international chambers of commerce. While issuing LC we should focus on name of seller, date, amount, product name and quantity, other details, precise and clear. All parties in LC deal in documents not goods or services.
Advantages of LC 
Letter of credit are benefited for seller and buyer
For Seller

• Protection against buyers payment default 
• Reduced production risk in case of order is changed or cancelled 

For Buyer

• Certainty of goods to be received
• LC shows solvency for the buyer and allows the buyer to reduce or eliminate initial payments   

Types of LC
Following types of Letter of Credit are discussed as under
a) Commercial LC
Most common LC in international trade
Subject to UCP (Uniform Customs and Practice for Documentary Credits)
Also known as import export LC

b) Stand by LC
Beneficiary of a stand by LC is paid when there is a breach of principals obligation
If Construction Company fails to deliver a project beneficiary of stand by LC can apply to nominated bank for payment

c) Revocable LC
Issuing bank can change or modify the LC anytime without informing the beneficiary
No endorsed by UCP
since seller’s interest is not protected not used much

d) Irrevocable LC
it cannot be changed or cancelled without the agreement of credit parties
All LC issued subject to UCP are irrevocable unless otherwise agreed between parties

e) Unconfirmed LC
LC that is not guaranteed by any bank other than issuing bank

f) Confirmed LC
LC that is guaranteed by second bank in addition to the issuing bank
only irrevocable LC can be confirmed

g) Transferable LC
Enable seller to assign part of whole of LC to another parties
Used when seller is not the sole manufacture or is a subsidiary company of a holding company

h) Back to back LC
Used when seller is a trader or export house
Seller issues back to back LC to his supplier
Advising bank or negotiating bank of seller will issue back to back LC by keeping original LC as collateral
Amount of back to back LC will be lower than original LC and the difference will be the traders profit

i) Red clause LC
 Provides for advance payment to seller for manufacturing packing dispatching and shipment of goods
Advance allowed by nominated bank of issuing bank to allow advance in red link
Advance paid against receipt and a written undertaking from seller that he will deliver the documents before credit expires
Unsecured credit risk of issuing bank
Advance is adjusted out of the proceeds later by nominated bank

j) Green clause LC
Provides for advance payment to seller for pre-shipment finance and storage of export terminal
Written in green ink usually used in export of commodities

k) Revolving LC
 Used when similar transaction will happen over a period of time
Same LC (revolving LC) will be used for all transaction
Eg: USD100000 worth of coal to be imported from Nepal to India per month for next 12 months
Revolving LC can stipulated that USD 10000 can be drawn on monthly basis for 12 months.

l) Sight LC
LC that demands payment on submission of required documents
Payments is made to the seller if the documents meet conditions of LC usually within 7 days by the nominated bank.

m) Usance LC
Usance LC also known as deferred payment letter of credit or time LC or term LC and is a letter of credit payable at a predetermined time or future date after the conforming documents are presented.