Characteristics and Classifications of Letter of Credit

A major advantage of the letter of credit is that it is highly customizable. Both the parties can agree to the terms and conditions that suit their business needs. Due to this, the characteristics and types of letter of credit have evolved into a wide range. Some of these are discussed here.

Commercial Letter of Credit

It is the most basic form of a letter of credit. In a commercial letter of credit, the importer issues the letter of credit with the exporter as the beneficiary. The issuing bank transfers it to the advising bank, which then makes payment to the exporter upon presentation of the necessary documents and proofs for meeting terms and conditions.

Confirmed Letter of Credit

Although a commercial letter of credit transfers the credit worthiness from the importer to the issuing bank, there is still a chance that even the issuing bank is unable to make the payment. So, the exporter can seek additional protection by getting a confirmed letter of credit where the advising bank also insures the payment. It will add to the cost of doing business for the exporter.

Deferred Payment Letter of Credit

A normal letter of credit requires the payment to the exporter upon receipt of the necessary proofs for complying with the shipment terms and conditions. On the other hand, a deferred letter of credit gives some time to the importer after the receipt of the goods or commencing of the shipment before he is required to pay the amount. It is beneficial in an established working relationship where the importer can only get funds for payment after he has started selling his goods.

Discounting the Letter of Credit

The exporter may need cash before the payment date as per the deferred payment clause. In this case, the advising bank can pay the agreed amount to the exporter after deducting a discounting fee before the actual payment is made by the importer. Such an arrangement is called discounting the letter of credit.

Red Clause and Green Clause Letter of Credit

In a red clause letter of credit, the beneficiary can request an advance payment of the agreed upon amount upon presenting the receipt and written an undertaking that the shipping documents will be delivered on an agreed upon date. Green clause letter of credit is similar to the red clause letter of credit, with an additional requirement of presenting the proof that the goods to be shipped have been warehoused.

Negotiable Letter of Credit

Negotiability is a common characteristic of a letter of credit. The parties can negotiate and agree to a time and mode of payment to be put in the terms and conditions.

Transferable Letter of Credit

A transferable letter of credit can be transferred multiple times, usually in domestic transactions. A non-transferable letter of credit can also be transferred if it hasn’t been exercised yet.

Revocable Letter of Credit

A revocable letter of credit can be revoked or modified without any prior consent of all the parties.

Standby Letter of Credit

The issuing bank will only make the payment when the applicant can’t. It is issued for a long term and is usually not transaction dependent.

Revolving Letter of Credit

There can be multiple withdraws until the pre-set limit is exhausted. It is also for a long term and not transaction dependent.

Mixed Payments Letter of Credit

There can be more than one payments terms and modes. For example, 50% of the payments are paid on sight, 25% is paid after 30 days of shipment and remaining 25% is paid when the shipment is received.

Third Party Letter of Credit

The applicant issues the letter of credit for the beneficiary while the actual transaction is done by a third party.

Local Letter of Credit

It is used in domestic trade transactions, where both the buyer and seller are from the same country. It is also called domestic or in-land letter of credit.^1–3