More about letters of credit

In this section we discuss the following topics and terminology within the area of documentary credits:

Sight credits

This is an easy enough term to explain. A sight credit or L/C is one which paid upon presentation of the required documentation (as stipulated in the original L/C) to the issuing or confirming bank. As exporter, you need to be careful however, as some L/Cs state that payment will only be made at a specified branch counter of the issuing or confirming bank (and won’t necessarily be paid or transferred directly into your account). The process of having to go to a particular branch and receive payment and then to transfer this payment into your account will slow down the payment process and may add further costs to the overall process. Thus, when working with sight L/Cs (or any L/Cs for that matter) make sure where payment will be made.

Usance credits

An L/C can specify any credit period that you have negotiated with the importer. A letter of credit that that incorporates a payment after a given term (e.g. 60 days) is known as a usance credit (also referred to as a term or acceptance credit). The correct phrase is hat the L/C is at usance, meaning that it will come into effect at some future date (also referred to as maturity).

You should note that the maturity date may also have further stipulations associated with it; for example:

  • 90 days sight
  • 120 days from Bill of Lading (B/L) date
  • 60 days and upon issuing of a FDA (US Food and Drug Administration) clearance

Some of these provisos can have a significant impact on your receiving payment and you should make yourself fully aware of any such provisos to your L/C. A usance/term credit will require you, as exporter, to finance the gap between delivery and payment.

Transferable credits

An irrevocable L/C may also be transferable. In the case of a transferable L/C, the exporter can transfer all or part of his/her rights to another party. Transferable letters of credit are often used when the exporter is the importer’s agent or a middleperson (i.e. export agent) between supplier and importer, and not the actual supplier of merchandise. With a transferable letter of credit, the exporter uses the credit standing of the issuing bank and avoids having to borrow or use his own funds to buy goods from a supplier. Hence, it is a viable pre-export financing vehicle. Before transfer can be made, the exporter must contact, in writing, the bank handling the disbursement of funds – the transferring bank. Transferable L/Cs can only be transferred based on the terms and conditions specified in the original credit, with certain exceptions. Therefore, it may be difficult to achieve flexibility and confidentiality with this finance method.

The transferring bank, whether it has confirmed the letter of credit or not, is only obligated to make the transfer to the extent and in the manner expressly specified in the L/C. Transferable L/Cs involve specific risks. When a bank opens a transferable letter of credit for a buyer, neither party can be certain of who will be the ultimate supplier. Both parties must rely upon the importer’s assessment of the exporter’s reputation and ability to perform. To reduce overall risk and prevent the shipment of substandard goods, an independent certificate of inspection may be required in the documentation.

For simplicity’s sake, many banks prefer single transfer and discourage multiple transfers, but will do multiple transfers if conditions are right. Partial transfers can also be made to one or several suppliers if the terms of the original L/C allow for partial shipments. The processing of this type of letter of credit can become complicated and tricky, requiring logistics coordination and the highest level of precision. Incomplete and/or ambiguous information on the transferable letter of credit almost always leads to problems. Furthermore, the beneficiary of the transferable letter of credit must be available throughout the entire negotiation process to assist the transferring bank.

Source: http://www.equipment.net/list/letterofcredit.htm

Revolving credits

The term “revolving” is used to describe a letter of credit, which, incorporates a condition whereby the credit amount is to be renewed or reinstated automatically without the need for a specific amendments to the credit. This type of credit is used when regular trade is conducted between an exporter and an overseas buyer. A revolving credit can be irrevocable or confirmed. Although a credit may, in theory, revolve in relation to amount, in practice this is rare, as it would mean that there might be no limit to the number of times a specific amount could be drawn. A credit, which revolves in relation to time, is a much more common form of a revolving credit. For example, a revolving credit could be made available for an amount of US$ 10 000 per month (irrespective of whether any sum was drawn during the previous month) with an overall validity of six months. A revolving credit may be:

  • Cumulative, i.e. any sum not utilised during the first period is carried over and may be utilised in the subsequent period.
  • Non-cumulative i.e. any sum not utilised during the first period ceases to be available in subsequent periods.

Back-to-back credits

Back-to-back L/Cs are another common occurrence in the world of international trade. When an exporter, who is not a manufacturer, but obtains goods from a supplier by acting as an export agent for the supplier for example, has received an L/C from an importer, the exporter, in turn, may request his bank to open a L/C in favour of his supplier on the strength of the existing L/C. These two credits are said to be “back-to-back”, that is to say the one is issued on the security of the other. A bank will only consider opening a second credit if the same goods are involved in both credits. In terms of the back-to-back L/C, the exporter is both the beneficiary/exporter of the first credit and the applicant/buyer for the second credit.

Standby credits

A standby L/C is one which is issued in favour of the exporter for the purpose of “backing-up” certain specified obligations of the importer. A standby letter of credit requires the exporter’s presentation of documents which indicate that importer has not met the obligations which the standby letter of credit backs-up. A standby letter of credit, therefore, is not intended to be drawn upon by the standby letter of credit beneficiary unless the standby letter of credit applicant does not meet its obligations as specified by the standby letter of credit.