Different Types of Letters of Credit
A letter of credit, also known as a bank credit letter, payment guarantee letter, or documentary credit, is a legal financial instrument issued by a bank or a financial institution to guarantee the buyer’s payment to the seller. In the event, if the buyer is unable to make the payment or perform the terms and conditions of the contract, the full or remaining amount will be covered by the buyer’s issuing bank to pay the exporters. An LC is a highly-secured and effective form of assuring on-time payment to the exporter while initiating an international transaction. This guide covers only the types of LC. To know more, read our LC guide!
Types of Letter of Credit
Different types of letters of credit can be chosen depending on the requirement of your business. Some of them are here as follows:
- 1. Commercial Letter of Credit
- 2. Export/Import LC
- 3. Transferable Bank Credit Letter
- 4. Non-transferable Bank Credit Letter
- 5. Revocable Payment Guarantee Letters
- 6. Irrevocable Payment Guarantee Letters
- 7. Standby Letter Of Credit
- 8. Confirmed LC
- 9. Unconfirmed LC
- 10. Revolving Bank Credit Letter
- 11. Back to Back LC
- 12. Red Clause Bank Credit Letter
- 13. Traveler's Letter of Credit
- 14. Credit on Sight/Sight Credit
- 15. Time Credit/Acceptance Credit
Let’s read about them in detail:
- 1. Commercial Letter of Credit -These types of LCs come with a direct payment method where the issuing bank releases the payment to the beneficiary or exporters.
- 2. Export/Import LC - Whether it is an import or export bank credit letter, it depends on who uses it. To put it simply, if a bank credit letter is used by the exporter, it will be known as an export documentary credit and vice-versa.
- 3. Transferable Bank Credit Letter- As the name suggests, this is a type of an LC where the beneficiary can transfer his/her right to the third parties. It means these payment guarantee letters are transferable to the next beneficiary in the chain and involve a middleman. The original beneficiary requests the bank to transfer either the entire payment or part thereof to the second beneficiary. Here, the first beneficiary acts as a middleman.
- 4. Non-transferable Bank Credit Letter - Contrary to the transferable LC, these bank credit letters cannot be transferred to another beneficiary and the payments can be prevented from getting by any second beneficiary.
- 5. Revocable Payment Guarantee Letters - A revocable LC is that which can be amended, canceled by the issuing bank without giving any prior notice to the beneficiaries. This is the reason these types of payment guarantee letters are not used frequently.
- 6. Irrevocable Payment Guarantee Letters - On the other hand, an irrevocable LC is that where the terms and conditions cannot be changed or amended by the bank without the prior consent of sellers. These are secure than revocable LCs.
- 7. Standby Letter Of Credit - Standby letter of credit is similar to the bank guarantee where the exporters are entitled to get the payment from the bank in the event of the buyer’s failure to perform the terms and conditions of the contract. In short, it ensures the exporter that the buyer will perform their part to the contract.
- 8. Confirmed LC - A documentary credit can be a confirmed LC when it involves a bank other than the issuing bank to guarantee the documentary credit. This second bank is the confirming bank (seller’s bank). The confirming bank ensures on-time payment to the seller in case if the buyer or issuing bank defaults. In simple words, where a confirming bank adds its own confirmation to the credit, it is known as a confirmed LC. Here, the beneficiary’s bank submits the documents to the confirming bank.
- 9. Unconfirmed LC - On the contrary, an Unconfirmed LC is only assured by the issuing bank and does not involve any second bank’s confirmation. To put it simply, only the issuing bank is liable to make the payment to the seller in case if the buyer defaults.
- 10. Revolving Bank Credit Letter - This type of letter of credit can be used to make plenty of draws within a particular limit during a particular period. The global traders use it in case of shipments that involve a diverse set of goods to be traded within a specific period.
- 11. Back to Back LC - A Back to Back LC is issued when the exporter requests his bank to issue an LC in favor of the supplier to secure raw material. It means there is a second LC issued with another LC as security. You can understand it by taking an example of a middleman buying goods from one party and selling it to another. The bank issues a Back to Back LC backed by the export LC.
- 12. Red Clause Bank Credit Letter - A Red Clause bank credit letter is where the buyer’s issuing bank provides a partial payment to the seller before the shipment of goods or availing of the services. This secures a certain supplier to accelerate the shipping process. It means there is a partial payment before the goods are shipped to the buyer.
- 13. Traveler's Letter of Credit - These are issued to the travelers going abroad with a guarantee that the drafts will be honored by the issuing bank made at foreign banks.
- 14. Credit on Sight/Sight Credit - In this type of letter of credit, the entrepreneur or businessman can get the payment by presenting the correct documents (like bills of exchange) to the lender with a sight letter. These LCs allow you to take the funds on an instant basis by presenting a sight credit.
- 15. Time Credit/Acceptance Credit - Bills of exchanges that are drawn and paid after a certain period between the lender and the borrower are known as time credit. In these letters of credit, these bills are accepted upon presentation and honored on their respective due dates.
These are some of the main types of letters of credit. To get a letter of credit, the consumer needs to provide a certain document to the issuing bank depending on the type. Before applying for a bank credit letter, both importers and exporters should be aware of all the types of bank credit letters to pick one as per the requirements of their business. Emerio Banque is a leading private institution providing a range of customized, safe, and reliable LCs.
Related Read: Difference Between Bank Guarantee And Letter Of Credit?