Three Types Of Letter Of Credit

Here are some of the types of major letters of credit:

We say that a letter of credit is modifiable and altered when it is a revocable letter of credit. This type of documentary credit does not need to have the approval of all parties involved in order to be modified. However, that is the main reason why they are not frequently used.

The one that is most commonly used is the irrevocable letter of credit. Different from the one we mentioned before, this one does need the approval of exporter, importer and banks in order to be modified or cancelled. This letter of credit is particularly preferred by exporters because it leaves them with no surprise at the time of payment when the merchandise arrives at the port of entry. Irrevocable letters cannot be modified by one person only.

Transferable letters of credit need to be also irrevocable. Through these types of documents, the exporter transfers the right to the merchandise and the payment of the goods. They are often used when the exporter and the importer work together or are part of the same company, or in the case of intermediaries.

When a transferable letter of credit is used, the exporter uses the credit granted by the issuing bank and avoids borrowing or using its own funds to purchase goods from the vendor. Hence, it is a viable tool for pre-export financing.

A letter of credit will show inside its terms and conditions whether the document can be transferred o not. When it is, prior to the transfer the exporter needs to contact the bank in writing and request a disbursement of the funds. The bank will transfer the funds only as it has been established in the terms and conditions of the letter of credit created with the consent of the interested parties. The letter of credit may be received but payment will wait until it is confirmed.

A transferable letter of credit may carry many specific risks to the holder. For one, when a bank receives one of those letters, neither the bank nor the buyer knows the supplier properly.

Banks will be left only with the evaluations of the importer and the exporter’s reputation as a way of judging the trustworthiness of the letter of credit. When they are accepted, supplementary quality controls are requested.

In order to simplify this procedure, many banks prefer to deal with single transfers instead of multiple ones. However, multiples transfers are performed when the conditions are appropriate. Partial transfers may be performed for one or more suppliers when the terms of the letter of credit allow it.