Different Types of Letters of Credit:

There are different types of LCs depending on the kind of business or transaction that is needed. In most cases, these secondary features are used to increase security and make the operation easier, faster, and more transparent.

While there is a definite time and place of each type of LC, business should be aware that certain additions and clauses stipulated might increase the bank’s fee, or add some features that can cause future problems for one of the parties involved.

Irrevocable:

An Irrevocable Letter of Credit allows the buyer to cancel or amend the LC, provided that other parties agree. This can be used to trade additional goods that were not a part of the original LC inside the same shipment or to allow the exporter of products extra time to fulfil their obligation.

Confirmed:

A Confirmed Letter of Credit is used to further ensure the seller by adding more security. This addition stipulates that if the issuing bank from the buyer doesn’t pay the requested amount of money, the seller’s bank guarantees payment.

This article can be added if there is reduced trust in the buyer, or if the money requested is crucial to stable financial liquidity of the seller.

Most Letters of Credit will include this clause in the agreement, especially in international trade between partners that haven’t done business in the past.

Transferable:

A Transferable Letter of Credit is commonly used when there are intermediaries involved in the transaction, or when there are more than two parties included in the Letter of Credit. In this case, the LC can be transferred to other entities, provided that the original beneficiary agrees.

This type is usually employed by the seller’s bank, especially when the seller is a Small and or Medium Enterprise, as a way to reduce the risk of the transaction to the bank, usually decreasing the price of the trade in the process.

Letter of Credit at Sight:

This article of the Letter of Credit stipulates that all payments will be fulfilled as soon as there is documentation that the goods or services have been received by the buyer. This payment can be made by the buyer, or by the buyer’s issuing bank, giving the buyer some additional time to fulfil the debt.

Contrary to this type of LC, there is the Standby Letter of Credit that doesn’t have this clause, and that needs to be activated in the case that the buyer can’t fulfil the payment.

Deferred or Usance Letter of Credit:

This type of LC is used to allow deferred payment from the buyer for a specified time period. This slightly reduces the risk of unintentional non-payment and lowers the cost of an LC. Additionally, a Deferred Letter of Credit is more enticing for the buyer, making it more likely for them to accept buying goods or services.

Red Clause:

A Red Clause Letter of Credit obligates the buyer’s issuing bank to provide partial payment to the seller prior to shipping products or providing the service. It is usually used to secure a certain supplier and to expedite the shipping process, but it often makes the LC significantly more expensive.

Find out more about the different types of Letter of Credit in the next page of our LC guide, here.

How Can an LC Help Your Business Grow?

Using Letters of Credit can significantly advantage your business, regardless if you are a seller or buyer of goods and services. This trading tool is legally binding in almost all countries of the world, providing better transparency and creating trust in your business.

Using an LC, you can do business with any company or business around the world while being certain that all goods agreed upon will be received and that all payments will be fulfilled.

For any company, this secured access to the global market means lower prices and better services in a wider market. Additionally, it means that you can safely offer your goods and services to any buyer around the world, with little risk that the products you have provided will not be paid for.

What are the Disadvantages of these Products?

The main disadvantage of using an LC compared to other methods is the relative cost of insurance, that may increase the overall cost of doing business. Letters of Credit should be used primarily on large shipments that may influence the liquidity and cash flow of the company, as well as when doing business with international buyers and sellers.

Additionally, an LC creates an issue for sellers, as the payment will be based on the documentation, and not the actual goods or services provided. Sellers need to be certain that the goods mentioned in the agreement are exactly as they are, with every minute detail included.

Finally, the disadvantage for the buyer is that the payment is connected to the documentation and not the actual provision of goods and services. Buyers need to ensure that all received products are exactly per specifications and have no flaws or damages before they create the necessary documentation that proves that they have received the goods.

Jason Gavin

Email: jasongavin44@gmail.com

Telephone/WhatsApp: + 44 7452 390049