In International trade, the buyer and the seller who are located in different countries, may not know each other and hence many times the problem of Buyer’s Creditworthiness hampers the trade between the buyer and the seller. The main objectives of the buyer and the seller in any international trade and contradictory in terms of Buyer will always try to delay the payment while the seller would like to receive funds at the earliest. Hence the LC play the vital role to solve the those opposite. Here below is the different types of Letter of credit in current practice.
1. Revocable Letter of Credit L/c
A revocable letter of credit may be revoked or modified for any reason, at any time by the issuing bank without notification. It is rarely used in international trade and not considered satisfactory for the exporters but has an advantage over that of the importers and the issuing bank.
There is no provision for confirming revocable credits as per terms of UCPDC, Hence they cannot be confirmed. It should be indicated in LC that the credit is revocable. if there is no such indication the credit will be deemed as irrevocable.
2. Irrevocable Letter of Credit L/C
In this case it is not possible to revoked or amended a credit without the agreement of the issuing bank, the confirming bank, and the beneficiary. Form an exporters point of view it is believed to be more beneficial. An irrevocable letter of credit from the issuing bank insures the beneficiary that if the required documents are presented and the terms and conditions are complied with, payment will be made.
3. Confirmed Letter of Credit L/C
A confirmed irrevocable letter of credit have been known that the advising bank, third party bank like ADB or IFC , adds its confirmation, makes its own independent undertaking to effect payment, negotiation or acceptance, providing the presentation of documents comply with the terms and conditions of the letter of credit. The advising bank, which may also be the confirming bank, assumes the country (political and economic) risk of the applicant’s country as well as the credit risk, failure and default of the issuing bank and effects payment to the beneficiary without recourse.
In order for a letter of credit to be confirmed, a bank accepting this risk would have a correspondent relationship with the issuing bank. If the advising bank does not have such a relationship, the letter of credit can be confirmed by an independent bank. The negative aspect here is the cost of adding another bank to the scenario.
Here below describe why the seller should request LC to be confirmed:
+ letter of credit standing of the issuing bank is unknown to the seller or viewed by the seller as questionable.
+ exchange controls in the buyer’s country may prevent local banks from honouring certain external payments.
+ the importing country is suffering economic difficulties: large external debt and/or high debt service ratios, a persistent negative balance of payments, or a record of being late or having defaulted on its international payments.
4. Red Clause / Green Clause
In the case of a red clause letter of credit (documentary credit with advance payment) the seller can request that the correspondent bank pay an agreed amount in advance (defined in the terms and conditions of the documentary credit). The advance is basically intended to finance the production or purchase of the goods to be delivered under the documentary credit. The advance is normally paid against receipt and commitment in writing from the beneficiary to subsequently deliver the transportation documents by an agreed date.
In the case of a green clause letter of credit (documentary credit with advance payment) the beneficiary can request that the correspondent bank pay an agreed amount in advance (defined in the terms and conditions of the letter of credit). The advance is basically intended to finance the production or purchase of the goods to be delivered under the documentary credit. Unlike the red clause letter of credit, the advance is paid only against receipt of an additional document providing proof that the goods to be shipped have been warehoused, as well as against receipt and written commitment from the beneficiary to subsequently deliver the transportation documents by an agreed date.
5. Back to Back Letter of Credit L/C
Back to Back Letter of Credit is also termed as Countervailing Credit. A credit is known as back to back credit when a L/c is opened with security of another L/c.
A back to back LC which can also be referred as credit and counter credit is actually a method of financing both sides of a transaction in which a middleman buys goods from one customer and sells them to another.
The practical use of this Credit is seen when L/c is opened by the ultimate buyer in favour of a particular beneficiary, who may not be the actual supplier/ manufacturer offering the main credit with near identical terms in favour as security and will be able to obtain reimbursement by presenting the documents received under back to back credit under the main L/c.
The need for such credits arise mainly when :
+ The ultimate buyer not ready for a transferable credit
+ The Beneficiary do not want to disclose the source of supply to the openers.
+ The manufacturer demands on payment against documents for goods but the beneficiary of credit is short of the funds
6. Transferable Letter of Credit L/C
A transferable documentary credit is a type of credit under which the first beneficiary which is usually a middleman may request the nominated bank to transfer credit in whole or in part to the second beneficiary.
The L/c does state clearly mentions the margins of the first beneficiary and unless it is specified the L/c cannot be treated as transferable. It can only be used when the company is selling the product of a third party and the proper care has to be taken about the exit policy for the money transactions that take place.
This type of L/c is used in the companies that act as a middle man during the transaction but don’t have large limit. In the transferable L/c there is a right to substitute the invoice and the whole value can be transferred to a second beneficiary.
The first beneficiary or middleman has rights to change the following terms and conditions of the letter of credit:
+ Reduce the amount of the credit.
+ Reduce unit price if it is stated
+ Make shorter the expiry date of the letter of credit.
+ Make shorter the last date for presentation of documents.
+ Make shorter the period for shipment of goods.
+ Increase the amount of the cover or percentage for which insurance cover must be effected.
+ Substitute the name of the applicant (the middleman) for that of the first beneficiary (the buyer).
Although infrequently used today, revolving letters of credit were a tool created to allow companies conducting regular business to issue a letter of credit that could “roll-over” without the company having to reapply, thus enabling business flow to continue without interruption as long as the terms and conditions, quantities, and other transaction details did not change. In addition, if a letter of credit were a revolving one, there were few ways to stop it from rolling over; so, should a conflict arise between the parties while the letter of credit was in place or should the products change, there was little recourse for either party. In the business world today, the fact is that, unless required by law or because of high risk, on-going business is usually conducted without of letters of credit.
8. Assignment of Proceeds
The right to the proceeds of a letter of credit can sometimes be assigned where the beneficiary of a letter of credit is not the actual supplier of all or part of the letter of credit and wants the bank to pay the supplier out of funds received from the letter of credit. The beneficiary may choose this option if he or she
+ does not want to request a transferable letter of credit from a buyer in order to keep the buyer from knowing who is the actual supplier of the goods.
+ does not have the necessary credit with the bank to issue a new letter of credit to a supplier.
An assignment of proceeds takes the form of an irrevocable instruction from the beneficiary to the bank requesting that it pay the supplier out of the proceeds of the letter of credit which becomes due when documents are presented in compliance with the terms of the letter of credit.
9. Inoperative LC
Inoperative LC, the beneficiary of the LC is not expected to ship until the LC is made operative.
Inoperative LC is sometimes stating such a clause “ this LC is become operative only after you are receiving letter …. from….” etc.
An inoperative LC in other words is assurance to the beneficiary that the applicant and /or the beneficiary are serious players in the market before they sign off the contract with a new applicant/buyer.