L/C in trade can be divided into several types depending on the agreement and nature of the contract. I will explain the main types of L/C here.
I believe it will help you deeply understand L/C and make your business more successful. Now, let ‘s take a quick look!
Origin of L/C and documentary L/C
L/C (letter of credit) was originally developed from a travel letter of credit. By travelers carry it, they can procure funds from the issuing bank.
Commercial L/C have come to be used for commercial transactions as well, and this is now commonly called as L/C.
As can be seen from its origin, it can be said that the effectiveness of L/C is to make it easier to move funds by using the creditworthiness of banks even in the other country.
Among commercial letters of credit, which require shipping documents when exporters roll out bills of exchange are especially called Documentary Credit.
It is frequently used in the world of trade.
Commercial L/C are now almost never used, as international credit services are available, such as credit cards have become widespread.
Nevertheless, in the world of trade L/C is still useful because it is effective for covering risks of shipping by vessels and airplanes.
Types of L/C in trading
There are several kinds of L/C, and it is necessary to know about them for conducting trade transactions. Let’s take a closer look at the nature of Irrevocable Credit, Confirmed Credit, Restricted Credit etc.
Irrevocable Credit and Revocable Credit
Irrevocable Credit; after L/C is issued, it is not able to cancel L/C or change the conditions without consent of the parties (beneficiary, issuing bank or confirmation bank in here).
Revocable Credit; It is possible to cancel or change L/C without canceling the parties’ agreement as a cancellable L/C.
This is not currently used and it is also removed from UCP 600. This is because if cancellation or change can be done without consent, the meaning of L/C for exporters will be diminished.
Currently, L/C with no notation is supposed to be treated as Irrevocable Credit.
Confirmed Credit and Unconfirmed Credit
Confirmed Credit means that if the creditworthiness of the Issuing Bank or the Importing Country is concerned, a bank other than the Issuing Bank (normally the Notifying Bank becomes the Confirming Bank) commit to payment.
Confirmation banks in the exporting country will have the same responsibilities as the issuing bank, so it is supposed to respond to purchase unless there is a discrepancy.
The responsibility of confirmation banks is that obligations for commitment will arise such as bankruptcy of issuing banks and cases where foreign exchange of importing countries is suspended.
However, if there is a discrepancy in the shipping documents, the confirmation bank will have no commitment obligation. Therefore, exporters need to pay close attention to the shipping documents.
“Confirmed” indication is indispensable for Confirmed Credit.
On the other hand, Unconfirmed Credit refers to L/C with payment guarantee of issuing bank only.
Depending on the trustworthiness of the exporter, whether the Confirmed Credit or the Unconfirmed Credit is to be decided by the importer at the time of L/C issuance request, choose one and apply to issuing banks.
Restricted Credit and General Credit
The L/C that limits the purchase of bills that the beneficiary comes down to a specific bank (e.g. the branch office of the issuing bank in the exporting place) due to the circumstances of the issuing bank is called a purchasing bank designated L/C.
On the other hand, L/C that a beneficiary can purchase at its own bank without designation by purchasing bank is called General Credit.
Normally, it is mostly taken General Credit, in such case the beneficiary can choose the bank that applies a favorable exchange rate.
In addition, L/C without either indication is to be treated as General Credit.
If a Nagotiating bank is specified, the beneficiary has to pay more fees and labor because the shipping documents will go to the designated bank via its own bank.
Therefore, it is desirable that the beneficiary asks the importer to delete the restricted wording.
This time I introduced some L/C types. In international transactions, it is possible to reduce the risks and costs of trading by taking confirmed L/C or General Credit.
Choosing the most suitable type of L/C according to the situation of your company or business partner will be a point of safe transactions.