Letters of Credit | What are the different types of Letter of Credit?

Importers and exporters normally require intermediaries such as banks or alternative financiers to guarantee payment and also the delivery of goods. Cash advances or trade credits on open accounts usually develop after the buyer and seller develop a trusted relationship. Therefore trade finance structures are used to support these relationships.

Letters of Credit (LCs) are instruments which guarantee payment to the seller if certain terms and conditions are met. They are frequently used in international transactions and have many different types. We have illustrated and defined the main different types of Letter of Credit below.



Revocable

The LC can be cancelled or changed at any time by the buyer or the issuing bank without notification. It is important to note that in the latest version of the UCP 600, revocable LCs have been removed for any transaction undertaken under their jurisdiction.

Irrevocable

The LC cannot be unilaterally reversed, unless all parties (the issuing bank, confirming bank, buyer and seller agree).



Confirmed

The status of a LC is ‘confirmed’ once the confirming bank (of the exporter) has added its obligation to the issuing bank. The obligation could be a guarantee or assurance of payment.

Unconfirmed

An unconfirmed LC is guaranteed only by the issuing bank (i.e., there is no confirmation by the advising bank). This type of confirmation is the most common in LCs, although where a jurisdiction has economic instability or political unrest, payment could be at risk.



Transferrable

If the beneficiary is an intermediary for the real suppliers of goods or services, the payment will need to be transferred to the actual suppliers.

Un-transferrable

An un-transferrable LC prevents payments from being transferred to third parties.



Straight

Here, the issuing bank has to pay the beneficiary.

Negotiable

The issuing bank is obligated to pay the beneficiary or any bank nominated by the beneficiary.



Restricted

In the case of a restricted LC only one nominated bank can be used for negotiation in relation to a letter of credit. Therefore, the authorisation of the issuing bank to make payment to the beneficiary is restricted to a specific nominated bank.

Unrestricted

The bank is not specified, which means that the letter of credit can be negotiated through any bank of the beneficiary’s choice.



Term (Usance)

Payment can be deferred in the case of a usuance LC which gives time for the buyer to inspect or even sell the goods.

Sight

If a LC is at sight, it is payable as soon as the documents have been verified and presented.

Want to know about Red and Green Clause Letters of Credit? See our post here.

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