Letter of Credit Types

Revocable and Irrevocable Letters of Credit

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Revocable and Irrevocable Letters of Credit

Revocable Letters of Credit: Revocable letter of credit can be modified or cancelled by the issuing bank after its issuance at any moment without seeking the beneficiary’s consent.

There is one exception regarding the revocation of the credit.

Issuing bank must reimburse any nominated or confirming bank with which the revocable letter of credit has been made available if these banks fulfill their obligations under the documentary credit terms against complying presentation before they receive the amendment or cancellation notice from the issuing bank.

A revocable letter of credit can serve as a limited security payment method to the beneficiaries, because they are subject to amendment or cancellation without their prior knowledge.

As a result revocable letters of credit are not used frequently in international trade.

UCP 500,which is the previous letters of credit rules published by ICC, was indicated that a letter of credit may be either revocable or irrevocable.

UCP 500 assumed that a letter of credit is irrevocable in default of the indication whether it is revocable or irrevocable.

Current letter of credit rules, UCP 600, do not cover revocable letters of credit. This point is made clear in article 3 of UCP 600:

A credit is irrevocable even if there is no indication to that effect.

Irrevocable Letter of Credit: Irrevocable Letter Of Credit (ILOC) is a letter of credit type which can not be cancelled or amended by the issuing bank without the agreement of the parties of the letter of credit transaction.

For example, issuing bank has no power to modify letter of credit terms if beneficiary does not find them acceptable.

In other words, every amendment at least requires beneficiary’s acceptance in order to be effective.

Irrevocable letters of credit give much more payment security to the beneficiaries than revocable letters of credit because of the reasons explained above. As a result, irrevocable letters of credit are the types of LCs that dominantly seen on the market place.

Banks will only add their confirmation to the irrevocable letters of credit. A confirming bank is not obligated to add its confirmation to any amendment. Also, transferable letters of credit should not be issued in a revocable form.

Letters of credits are transmitted through banks via a secure and authenticated system which is called SWIFT.

There are various swift message types for different situations. For example banks use MT700 (Message Type 700) when issuing a letter of credit.

We will examine SWIFT messages in detail later on.

Here we want to explain one section of MT700 swift message (Issue of a Documentary Credit) which contains the information regarding the type of the documentary credit.

In order to understand the letter of credit type we need to check Field 40A in a MT700 swift message. This field contains the necessary information regarding the form of the documentary credit. There are seven possibilities as seen below.

  • IRREVOCABLE : The documentary credit is irrevocable.
  • REVOCABLE: The documentary credit is revocable.
  • IRREVOCABLE TRANSFERABLE: The documentary credit is irrevocable and transferable.
  • REVOCABLE TRANSFERABLE: The documentary credit is revocable and transferable.
  • IRREVOCABLE STANDBY: The standby letter of credit is irrevocable.
  • REVOCABLE STANDBY: The standby letter of credit is revocable.
  • IRREVOC TRANS STANDBY: The standby letter of credit is irrevocable and transferable.

Presentation – Types of Letters of Credit

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Presentation - Types of Letters of Credit

Commercial Letters of Credit

Commercial Letters of Credit

  • Commercial credits are used mainly in export and import transactions of tangible goods.
  • Majority of commercial letters of credit are issued subject to the latest version of UCP (Uniform Customs and Practice for Documentary Credits).
  • UCP (Uniform Customs and Practice for Documentary Credits) are the set of rules that governs the commercial letters of credit procedures.

Standby Letters of Credit

Standby Letters of Credit

  • Standby credits are used mainly in contraction projects as well as export and import transactions of tangible goods.
  • Majority of standby letters of credit are issued subject to the latest version of ISP (International Standby Practices).
  • ISP (International Standby Practices) are the set of rules that governs the Standby letters of credit procedures.

Irrevocable Letter of Credit

Irrevocable Letter of Credit

  • Irrevocable means not to be revoked or recalled; unalterable according to Kernerman Webster’s College Dictionary.
  • Irrevocable Letter of Credit is a type of letter of credit which can not be cancelled or amended without the written agreement of the credit parties.
  • If credit is unconfirmed unconfirmed than beneficiary beneficiary and issuing issuing bank must reach an agreement on the amendments.
  • If credit is confirmed than beneficiary, issuing bank and confirming bank must reach an agreement on the amendments.
  • All credits issued subject to UCP 600 are irrevocable unless otherwise specified.

Revocable Letter of Credit

Revocable Letter of Credit

  • Revocable means capable of being revoked; able to be cancelled according to Kernerman Webster’s College Dictionary.
  • Irrevocable Letter of Credit is a type of letter of credit which can be cancelled at any time without prior notification to the beneficiary.
  • Revocable credits can not be confirmed. So all revocable credits are
    need to be unconfirmed.
  • Revocable credits can not be confirmed. So all revocable credits are
    need to be unconfirmed.
  • Unconfirmed credits can be amended or cancelled by the issuing bank at any time without prior agreement of the beneficiary.
  • All credits issued subject to UCP 600 are irrevocable unless otherwise specified.
  • Revocable credits can still be issued subject to UCP 500.

Transferable Letter of Credit

Transferable Letter of Credit

  • Transferable Letters of Credit are suitable for triangle trade. Triangle trade is a trade where a middleman exist between the buyer (importer) and the seller (exporter).
  • Transferable letter of credit issued in favor of the middleman. Then middleman transfers part of the credit to the ultimate supplier of the goods.
  • Middleman’s Middleman’s commission commission is the difference difference of these two credit amounts amounts. (issued amount-transferred amount=commission of the middleman)
  • Transferable Letters of Credit can be issued subject to UCP 600.
  • Transferable credit can be transferred more than one beneficiary. (partial transfer is allowed)
  • Transferred credits can not be transferred to another second beneficiary once more.

Back-to-Back Letter of Credit

Back-to-Back Letter of Credit

  • Back-to-Back Letters of Credit are suitable for triangle trade. Triangle trade is a trade where a middleman located between the buyer (importer) and the seller (exporter).
  • There are two separate letters of credit exist in a back-to-back letter of credit transaction.
    • Buyer issues 1st. letter of credit in favor of the middleman middleman.
    • Middleman issues 2nd. letter of credit in favor of the ultimate supplier of the goods.
  • As back-to-back letters of credit contain two independent credits, issuing bank of the 2nd letter of credit has to bear substantial amount of payment risk. For this reason back-to-back letters of credit are rarely used in international trade.

Revolving Letter of Credit

Revolving Letter of Credit

  • If buyer and seller are trading the same commodity regularly on a certain period of time than they may choose to work with a revolving letter of credit instead of issuing a new LC every shipment.
  • Buyer’s bank (issuing bank) issues a letter of credit that replenishes either in value or in time.
  • Revolves by value : Letter of credit is reissued automatically when credit amount is utilized.
  • Revolves by time : an amount is available in fixed installments over a period

Revolving Letter of Credit

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Revolving Letter of Credit

Revolving letter of credit is a special type of letter of credit, which is not covered under the UCP 600 rules.

Contrary to popular belief, revolving letters of credit are not used frequently.

They may be utilized in limited occasions in international trade, especially when exporters and importers sign a long term commercial sales contract, which covers shipments of the same commodity on a regular basis such as;

  • Shipments of 10.000 mtons of iron ore from Australia to China monthly basis for a 6 months period of time
  • Shipments of textile products monthly basis from China to USA for a 12 months period of time.

An exporter and importer, who have concluded a contract as indicated above and wish to have a letter of credit issued to satisfy their contractual payment obligations, may apply for a revolving letter of credit.

Definition:

A revolving letter of credit is a special letter of credit type, which is structured in a way so that it revolves either in value or in time covering multiple-shipments over a long period of time under a single letter of credit.

Types of Revolving Letters of Credit:

i. Revolvement Based on Time: A fix amount could be drawn under letter of credit within each specific period of time as indicated in the documentary credit until letter of credit expires.

Example: Letter of credit stipulates that 100.000,00 USD can be drawn on monthly basis for a 12 months validity period.

  • Type 1 – Non-Cumulative Revolving Letter of Credit: For a non-cumulative revolving letter of credit, the beneficiary can draw each revolving amount for any given period, and any unused portions cannot be drawn on the subsequent periods.

Example: Using the above example, the shipper could still ship USD 100.000,00 each month and be fully paid. If the shipper shipped USD 90.000,00 in a given month, they would still be paid provided that partial shipment is allowed for each shipments, but they could not get the additional USD 10.000,00 by shipping excessive amount on the upcoming months.

Type 2 – Cumulative Revolving Letter of Credit: Cumulative revolving letter of credit means that the unused sums in the L/C can be added to the upcoming shipments.

Example: Using the above example, the shipper could still ship USD 100.000,00 each month and be fully paid. If the shipper shipped USD 90.000,000 in a given month, they would still be paid, and they could get the additional USD 10.000,00 by shipping extra in the next months until letter of credit reaches to expiry.

ii. Revolvement Based on Value: A fixed amount is replenished every time just after it is utilized by the beneficiary within the overall validity of the revolving letter of credit.

Revolvement dependent upon value could be very risky for the issuing banks as beneficiaries can make excessive presentations if issuing banks fail to specify maximum letter of credit limit.

Red Clause Letter of Credit Sample

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Red Clause Letter of Credit Sample

Letter of credit that carries a provision (traditionally written or typed in red ink) which allows a seller to draw up to a fixed sum from the issuing bank, in advance of the shipment can be defined as a red clause letter of credit.

Red clause letters of credit supply advance payments to the exporters before they actually ship the goods to the importers.

Exporters receive advance payments under red clause letters of credit mostly from the issuing banks inside the letters of credit.

It is also possible that the advance payments are payable outside of the letters of credit from the importers to the exporters.

Normally, the issuing banks make the advance payment under red clause letters of credit against presentation of advance payment guarantees issued by the bankers of the exporters, guaranteeing a refund in the event of failure to ship under the credit.

———————————– Instance Type and Transmission —————————-
Original received from SWIFT
Priority/Delivery : Normal
Message Output Reference : 1225 121016XXXXXXXXX5657939061
Correspondent Input Reference : 1225 121016XXXXXXXXX1178375172

—————————————- Message Header —————————————–
Swift OUTPUT FIN 700 Issue of a Documentary Credit
Sender : ASIATRISXXX
Receiver : PCBCCNBJXXX
————————— Message Text ———————————-
27: Sequence of Total
1/1

40A: Form of Documentary Credit
IRREVOCABLE

20: Documentary Credit Number
ASIAIM00004050

31C: Date of Issue
130722

40E: Applicable Rules
UCP LATEST VERSION

31D: Date and Place of Expiry
131230-TURKEY

50: Applicant
ASIA BANK OF TURKEY TAS
BUYUK HAN MAH. ISMAIL HAKKI BEY
CAD. NO:20 34500
SISLI,ISTANBUL/TURKEY

59: Beneficiary – Name & Address
NINGBO PLASTIC MACHINERY CO., LTD.
PLS SEE FIELD 47A ITEM 7 FOR ADDRESS DETAILS
32B: Currency Code, Amount
Currency : USD (US DOLLAR)
Amount : #327.000,00#

39B: Maximum Credit Amount
NOT EXCEEDING

41A: Available With…By… – BIC
ASIATRISXXX
ASIA BANK OF TURKEY TAS BUYUK HAN MAH. ISMAIL HAKKI BEY CAD. NO:20 34500
SISLI,ISTANBUL/TURKEY
BY MIXED PYMT

43P: Partial Shipments
NOT ALLOWED

43T: Transhipment
ALLOWED

44E: Port of Loading/Airport of Departure
ANY CHINESE PORT

44F: Port of Discharge/Airport of Destination
HAYDARPASA PORT ISTANBUL

44C: Latest Date of Shipment
131209

45A: Description of Goods &/or Services
NEW PLASTIC CUP MAKING LINE QTY:1 SET U/P: USD 327.000 FOR TOTAL AMOUNT: USD 327.000,00 AS PER BENEFICIARY’S PROFORMA INVOICE REF NO: NB130522 DD:04.07.2013
INCOTERMS 2010: CIF HAYDARPASA ISTANBUL TURKEY

46A: Documents Required

  • DULY SIGNED COMMERCIAL INVOICE IN 2 ORIGINALS AND 3 COPIES CERTIFYING IN STRICT CONFORMITY WITH THE BENEFICIARY’S PROFORMA INVOICE REF NO: LL130522 DD:04.07.2013 AND SHOWING QUANTITY, DESCRIPTION , ALSO STATING FOB VALUE OF THE GOODS FREIGHT AND INSURANCE SEPARATELY.
  • CLEAN ON BOARD B/L IN 3/3 ORGS. AND 3 N/N COPIES ISSUED TO THE ORDER OF ISSUING BANK NOTIFY APPLICANT,MARKED: ‘FREIGHT PREPAID’.
  • PACKING LIST IN 2 ORG.S AND 2 COPIES.
  • BENEFICIARY’S CERTIFICATE 1 ORG. STATING THAT SHIPMENT DETAILS INCLUDING DATE AND PLACE OF LOADING,NAME AGE,NATIONALITY,IMO NUMBER OF THE VESSEL,VALUE OF THE GOODS, GROSS AND NET WEIGHTS OF THE GOODS AND THE REF.NO OF THE L/C HAVE BEEN SENT TO OUR BANK’S FAX NO:+90 212 600 50 10 WITHIN 2 DAYS AFTER SHIPMENT DATE FOR INFORMATION PURPOSES.(FAX REPORT AND SHIPMENT DETAILS HAVE BEEN ATTACHED TO THIS DOC.)
  • CERTIFICATE BY BENEFICIARY STATING THAT ‘CE’MARK HAS BEEN LABELLED ON PACKAGES OF THE GOODS AND TECHNICAL DOCUMENTS IN STRICT CONFORMITY CONCERNING LEGISLATION
  • FULL SET INSURANCE POLICY ISSUED TO THE ORDER OF ISSUING BANK FOR FULL CIF VALUE PLUS 10 PERCENT AND STATING THE NAME, PHONE AND FAX NUMBERS OF A CLAIMS SETTLING AGENT IN TURKIYE AND CLAIMS PAYABLE IN TURKIYE COVERING THE FOLLOWING RISKS FROM WAREHOUSE TO WAREHOUSE:
    +INSTITUTE CARGO CLAUSES (A)
    +INSTITUTE WAR CLAUSES (CARGO)
    +INSTITUTE STRIKE CLAUSES (CARGO)
    +RIOTS AND CIVIL COMMOTIONS,
    ALSO INSURANCE TO CERTIFY THAT COVER IS NOT SUBJECT TO A FRANCHISE OR AN EXCESS (DEDUCTIBLE).
  • CERTIFICATE OF ORIGIN IN 1 ORG. AND 1 COPY LEGALIZED BY THE LOCAL CHAMBER OF COMMERCE ATTESTING THAT GOODS ARE CHINA ORIGIN.

47A: Additional Conditions

  • ALL DOCUMENTS MUST BEAR OUR L/C REF.
  • IN CASE OF PRESENTATION OF THE DOCUMENTS WITH DISCREPANCIES, USD 100,00 WILL BE DEDUCTED FROM THE PROCEEDS AS AN ADDITIONAL PROCESS FEE.
  • DOCUMENTS ISSUED BEFORE L/C OPENING DATE NOT ACCEPTABLE.
  • PAYMENTS TO BENEFICIARY UNDER RESERVE AND ANY KIND OF GUARANTEE ARE NOT ACCEPTABLE
  • ALL DOCS MUST BE ISSUED OR FILLED IN ENGLISH
  • BENEFICIARY’S ADDRESS: DEVELOPED AREA OF NINGBO ECONOMIC DEVELOPMENT ZONE NINGBO CITY CHINA

71B: Charges
ALL BANKING CHARGES AND COMMISSIONS OUTSIDE OF TURKEY ARE FOR BENEFICIARY’S ACCOUNT.

48: Period for Presentation
21 DAYS AFTER SHIPMENT DATE BUT WITHIN CREDIT VALIDITY.

49: Confirmation Instructions
WITHOUT

78: Instruction to Paying/Accepting/Negotiating Bank

  • 30 PCT OF L/C AMOUNT SHALL BE PAID IN ADVANCE UPON RECEIVING ADVANCE PAYMENT GUARANTEE,
  • 70 PCT OF L/C AMOUNT SHALL BE PAID UPON RECEIPT OF CREDIT CONFORM DOCS.
  • PLS ADVISE US THE REMITTANCE OF THE DOCS. BY MT 754 MSG. QUOTING OUR REF.

72: Sender To Receiver Information

  • PLS SEND THE DOCS TO FOLLOWING ADDRESS BY DHL IN ONE LOT: ASIA BANK OF TURKEY TAS BUYUK HAN MAH. ISMAIL HAKKI BEY CAD. NO:20 34500 SISLI,ISTANBUL/TURKEY
    ———————– Message Trailer ——————————
    {MAC: 00000000}
    {CHK: XXXXXXXX}

At Sight Letter of Credit

Ozgur Eker (CDCS) At Sight, Payment Types of Letter of Credit ,
At Sight Letter of Credit

According to the current letters of credit rules, UCP 600, credits must state how they are available to beneficiaries in terms of payment type.

UCP 600 – Article 6-b states that “A credit must state whether it is available by sight payment, deferred payment, acceptance or negotiation.”

On this article we explain letters of credit issued available by at sight payment.

Definition: 

At sight payment is a payment due on demand. At sight letter of credit can be defined as a letter of credit that is payable as soon as the complying documents have been presented to the issuing bank or the confirming bank.

Payment Time:

When should the beneficiary expect to receive the payment from the issuing bank or the confirming bank under an at sight letter of credit?

If is the issuing bank or the confirming bank finds out that the presentation is complying, then they should transmit the funds to the beneficiary at the earliest convenience.

We know that banks have 5 working days to determine whether a presentation is complying or not.

As a result, under a complying presentation where no additional reimbursement time-frame has been defined, the beneficiary should expect to receive the letter of credit amount from the issuing or confirming bank between 7-10 days after documents received by these banks.

Advantages:

In which circumstances at sight letter of credit can be preferred?

At sight letter of credit can be used in situations where the beneficiary needs funds as soon as the shipment is completed.

At sight letters of credit are mostly used in small to medium size transactions where applicant is located in a relatively high risk country.

Risks:

What are the potential risks in at sight letters of credit?

There is no additional risks associated with at sight letters of credit other than ordinary letters of credit possess.

Swift Usage:

At sight letter of credit is shown in a MT700 swift message under field 41a as below,

MT 700 Issue of a Documentary Credit
Field 41a: Available With … By …

  • BY ACCEPTANCE
  • BY DEF PAYMENT
  • BY MIXED PYMT
  • BY NEGOTIATION
  • BY PAYMENT

What are the Differences Between Standby Letters of Credit and Commercial Letters of Credit?

Ozgur Eker (CDCS) Commercial Letter of Credit, Letter of Credit Types, Standby Letter of Credit , ,
What are the Differences Between Standby Letters of Credit and Commercial Letters of Credit?

Standby letters of credit and commercial letters of credit are two main documentary credit types used in international trade transactions.

A standby letter of credit is a bank’s undertaking of fulfilling the applicant’s obligations.

In case, the applicant can’t fulfill contractual obligations against the beneficiary of the standby letter of credit, then the beneficiary can apply to the issuing bank for full compensation.

A commercial letter of credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.

Commercial letters of credit are mainly used as a primary payment method in export and import of the tangible goods in international trade.

Table 1: Differences Between Standby Letter of Credit and Commercial Letter of Credit

Differences between standby letter of credit and commercial letter of credit

 

Common Characteristics of Standby Letters of Credit and Commercial Letters of Credit:

Both standby and commercial letters of credit;

  • are irrevocable and conditional payment promises, which is given by a trusted financial institution mostly by a bank.
  • independent payment mechanisms, whatever contracts they may base.
  • are governed by ICC’s rules, ISP 98 and UCP 600, respectively.
  • have a documentary nature.

Types of Letters of Credit

Ozgur Eker (CDCS) Back-to-Back Letter of Credit, Clean Letter of Credit, Commercial Letter of Credit, Confirmed Letter of Credit, Irrevocable Letter of Credit, Letter of Credit Basics, Letter of Credit Types, Red Clause Letter of Credit, Revocable Letter of Credit, Standby Letter of Credit, Transferable Letter of Credit, Unconfirmed Letter of Credit
Types of Letters of Credit

From their origins in 18th-century traveler’s credit systems to today’s cornerstone role in international commerce, letters of credit (LCs) have transformed into all-round, secure financial instruments critical for mitigating risk in cross-border transactions.

These tools are broadly categorized into commercial letters of credit—the go-to payment method for facilitating trade deals—and standby letters of credit, which act as safety nets for contractual obligations.

Beyond these core types, specialized variations like red clause, confirmed, transferable, and back-to-back letters of credit offer tailored solutions to meet the unique demands of buyers and sellers.

In this post, we break down the different types of letters of credit and how they secure global transactions.

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