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The letter of credit is a payment tool that can be used to finance both domestic and international purchases. There are many different types of letters of credit.
What is a letter of credit?
A letter of credit is basically a payment instrument in the name of a buyer or importer. With a letter of credit in good order, the bank will pay for the goods or goods that the bank is purchasing from a seller or exporter, which is the beneficiary of the letter of credit. In this way, the payee secures his/her payment, and the customer uses the bank as an intermediary for the transaction.
Types of Letters of Credit
Now that we know what a letter of credit is, let’s see what types of letters there are:
Irrevocable letter of credit: This type of LC cannot be modified or canceled. It presupposes an unbreakable commitment between the issuer and the beneficiary. This makes it much safer for the issuer.
Trading credit: Through this type of LC, the issuing bank undertakes to pay that letter of credit and the respective letters to any bank that submits them.
Transferable credit: This type of LC grants the beneficiary the option of passing the open credit in their favor to one or more beneficiaries.
Revocable letter of credit: This type of LC allows the bank to modify or cancel the credit at any time before it has been used by the beneficiary. This type of LC represents some degree of insecurity for the seller.
Confirmed letter of credit: This type of LC is issued by one bank and confirmed by another. It acts as collateral. Hence, it is also an irrevocable letter of credit. In this case, the confirming bank is liable to the beneficiary under the terms of the issuing bank from the date the confirmation was delivered.
Derivative credit or “Back to Back”: This letter of LC is transferable. It is an open credit to the beneficiary which in turn constitutes a guarantee of another credit ordered by the beneficiary and in favor of a third party.
Revolving Credit: This letter of LC is used when the buyer makes periodic transactions. In this case, the bank agrees to pay for each of the seller’s dispatches without requiring the payee to request payment for each new shipment. This letter of credit is presented under two systems:
- Auto-renewal: In this mode, the bank pays the full value of the credit automatically until the credit is consumed.
- Conditional renewal: The bank undertakes to pay for each firm. However, in case of non-compliance, the bank can refuse to renew the payment of the firms, so this modality represents a greater risk to the seller.
Credit on sight: This letter of LC is filed to support a spot sale purchase and operates only with the submission of the shipping documents which are specified in the contract.
A final word
A letter of credit is a means of payment and/or financing by which a customer requests an order from the bank to pay a certain creditor in such a way that the creditor secures his/her money and delivers the corresponding goods. In addition, each transaction has a letter of credit type so the payer can order both payment and financing letters of credit for different sellers, provided that the bank approves the issuance of such a letter of credit.
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