Traveler's letters of credit, which were commonly used in eighteenth century, were the first financial instrument contains very similar characteristics with the contemporary letters of credit.
Commercial Letters of Credit
Commercial letters of credit are mainly used as a primary payment tool in international trade such as exporting and importing transactions. Majority of commercial letters of credit are issued subject to the latest version of UCP (Uniform Customs and Practice for Documentary Credits). The ICC publishes UCP, which are the set of rules that governs the commercial letters of credit procedures.
Standby Letters of Credit
Commercial letters of credit are a means of payment to be utilized when the principal perform its duties. As an example, let us consider an exporter who ships the goods according to the sales contract and apply to the nominated bank for the payment. If the nominated bank decides that the presentation is conforming to the terms and conditions of the credit and the UCP rules then exporter will be paid. This situation is just contrary in standby letters of credit.
A payment is made to the beneficiary of a standby letter of credit when there is a breach of the principal's obligation. As an example, let us consider a construction company that has been awarded with a tender. If this construction company cannot fulfill its obligations under the project contract beneficiary of the standby letter of credit can apply to the nominated bank for the payment. However, the nominated bank considers only the terms and the conditions of the standby letter of credit and the rules governing the credit when deciding a complying presentation. One point that needs to be stressed is that standby letters of credit have their own rules, which are called The International Standby Practices 1998 (ISP98). They are also published by ICC. However, a standby letter of credit can be issued subject to either the UCP or the ISP.
Revocable Letters of Credit
Revocable letters of credit give issuer the amendment or cancellation right of the credit any time without prior notice to the beneficiary. Since revocable letters of credit do not provide any protection to the beneficiary, they are not used frequently. In addition, UCP 600 has no reference to revocable letters of credit. All credits issued subject to UCP 600 are irrevocable unless otherwise agreed between the parties.
Irrevocable Letters of Credit
Irrevocable Letters of Credit cannot be amended or cancelled without the agreement of the credit parties. Unconfirmed irrevocable letters of credit cannot be modified without the written consent of both the issuing bank and the beneficiary. Confirmed irrevocable letters of credit need also confirming bank's written consent in order any modification or cancellation to be effective.
From traveler's letters of credit days to today's complex global economy, the letters of credit have been performing their duties as a secure and reliable payment method. Actually, during this period letters of credit have gained a very flexible structure that can satisfy different needs of different types of international trade practitioners. In this article, we will discuss types of letters of credit.