What is a Letter of Credit?

A letter of credit is a financial document provided by a third party, typically a bank or a financial institution, that guarantees the payment of funds for goods and services to the seller, once the seller has submitted required documents. The third party has no interest in the transaction. Banks and other creditworthy financial institutions, such as insurance companies and mutual funds, may issue letters of credit.

When one of these financial institutions chooses to issue a letter of credit, it is normal for a bank to offer it. In such cases, the bank does not necessarily incur financial liability if scenarios, such as insolvency, occur. However, this must be indicated on the letter of credit, otherwise the bank may be held liable under the laws of different countries.

Commercial Letter of Credit

A standard letter of credit; also called as documentary credit.

Export/Import Letter of Credit

The same letter of credit can be called export or import, depending on who uses it. The exporter will term it as an exporter letter of credit, whereas an importer terms it as an importer letter of credit.

Transferrable Letter 0f Credit

A letter of credit that allows the beneficiary to transmit the payment in whole, or in part, to another supplier in the chain. This usually occurs when the beneficiary is only an agent for the current provider. Such a letter of credit allows the beneficiary to submit its own documents, but to transfer the money further.

Un-Transferrable Letter of Credit

A letter of credit that does not transfer money to third parties. The recipient is the only recipient of money, and can no longer use the letter of credit to pay someone.

Revocable Letter of Credit

A letter of credit that the issuing bank, or the purchaser, may change the terms at any time without notifying the seller/beneficiary. These types of messages are often not used, because there is no protection for the beneficiary.

Irrevocable Letter of Credit

A letter of credit that, without the approval of the beneficiary, a bank cannot make any changes.

Standby Letter of Credit

A letter of credit designed to ensure payment in case of unreasonable circumstances. If the beneficiary proves that the promised payment has not been made, the waiting letter of credit will expire. It does not facilitate transactions, but guarantees payment.

Confirmed Letter of Credit

A letter of credit guaranteeing payment to the Beneficiary by the Consulting Bank. Only an irrevocable letter of credit is verified by an advisory bank. The beneficiary has promised to pay one from the issuing bank, and one from the advisory bank, respectively.

Revolving Letter of Credit

A letter of credit used for multiple payments, instead of issuing letters at each stage of the transaction.

Back to Back Letter of Credit

A letter of credit commonly used in transactions involving brokers. There are two letters of credit – the first to the broker at the buyer bank, and the second to the seller at the broker bank.

Red Clause Letter of Credit

A letter of credit partially paid to the beneficiary before the goods are shipped or services are performed. The advance is paid in return for the written confirmation of the seller, and the receipt.

Green Clause Letter of Credit

A letter of credit paid to the seller in advance, without incurring written agreements and receipts of the goods.

Sight Letter of Credit

A letter of credit requesting payment for submission of required documents. The bank reviews the documents, and pays the beneficiary if the documents meet the conditions of the letter of credit.

Deferred Payment Letter of Credit

A letter of credit guaranteeing payment after a certain period of time. The bank can review the documents early, but payments are made to the beneficiary after the agreed time has passed. It is also known as usance letter 0f credit.

Direct Pay Letter of Credit

A letter of credit requiring the issuing bank to pay the beneficiary directly and then be reimbursed by the buyer. The recipient cannot interact with the buyer.