Different types of Credit letters
Various types of LCs are in operation depending upon the need. Based on the nature and function, LCs may be categorized as under:
Based on Scope for Cancellation
- Revocable Letter of Credit: A revocable letter of credit is one, which can be revoked (either cancelled or amended), by the issuing bank without giving notice to any of the parties concerned. A revocable letter of credit is disadvantageous from the exporter’s point of view.
- Irrevocable Letter of Credit: Almost all LCs opened in the course of international trade are irrevocable letters of credit. Cancellation or any amendment to such an LC cannot be made without the prior acceptance of the parties to the said LC like the applicant, the confirming bank, if any and the beneficiary. An irrevocable letter of credit is more desirable form the exporter’s point of view.
- Confirmed Letter of Credit: In addition to the issuing bank, another bank will add its confirmation to the LC. In other words, a confirmed letter of credit will have the guarantee of not only the issuing bank but also of the confirming bank. It should be noted that only irrevocable letters of credit could be confirmed. The confirming bank will add its confirmation only if requested by the issuing bank. Confirming banks are usually located in the country of the beneficiary.
Based on Mode of Payment
- Payment Credit: Under this credit, payment will be made to the beneficiary on submission of the required documents provided they are in compliance with the LC terms. Payment credits do not usually call for drawing of bills. Under payment credit, the issuing bank nominates a bank in the exporter’s country to effect payment on its behalf if the documents are in conformity with the LC.
- Deferred Payment Credit: This type of credit is a usance credit, where payment is made on the due dates specified in the credit. The beneficiary may or may not be required to draw drafts. The drawer bank itself may draw promissory notes and pass on to the beneficiary for claiming payments on due date.
- Acceptance Credit: This credit is a usance credit, where it is mandatory for the beneficiary to draw a draft on the drawer/specified tenor. The drawer bank will accept such drafts and make payment on the respective due dates on presentation of the relevant bill of exchange.
- Negotiation Credit: This credit may be a slight credit or a usance credit. Under a sight credit, payment is made immediately, while under a usance credit payment is made after a specified tenor. A negotiation credit may be freely negotiable in which case the beneficiary may approach any bank for the presentation of documents. This implies that when a credit is freely negotiable, any bank is a nominated bank.
Based on Tenor:
- Sight Credit: When payment is made on sight( either on demand or presentation), such credit is called a sight credit. Drawing of drafts is not compulsory under sight credit. Under a sight payment credit (if drawing a draft is not required) payment can be made against submission of stipulated documents.
- Usance Credit: Also referred to as term credit, this credit requires drafts to be drawn on the drawee / specified bank indicating the tenor. Such drafts will be accepted by the drawee and paid for at the end of the usance period.
Based on Availability Style
- Revolving Credit: A letter of credit whereby the credit available to the beneficiary gets reinstated to the original amount once a drawing is made is called revolving credit. The amount under this credit may revolve in relation to time or value. Revolving credit may be of two types. In the first type, the amount gets reinstated immediately when the beneficiary makes a drawing. In the second type, the amount will be revived only when the issuing bank gives a confirmation. This may take place after the issuing bank receives documents and payment made, or the issuing bank confirms the fact of receipt of documents.
- Installment Credit: It stipulates that shipments may be made in installments’ at specified periods of time. Installment credit differs from simple credit, which permits quantity is stipulated. On the other hand, under a simple credit, which permits partial shipments, there is no stipulation as to the time and quantity.
- Deferred Credit: This credit is mostly used in those trades where a portion of goods is paid for by the buyer after verification of goods or after assessing the value of the goods, taking into account the quality, shortages, etc. the date for payment of the undrawn balance may or may not be specified. Hence such type of credit is called deferred Credit.
- Transit Credit: Normally, when an LC is opened, it will be advised to the beneficiary by a bank that is based in the beneficiary’s country. However in transit credit, the service of a bank situated in a tired country will be used. In such credit, the advising bank will be situated in a country other than the beneficiary’s. Such a requirement may be called for in cases where the opening bank has no corresponding relations with any bank in the beneficiary’s country. Transit credit may also be opened by countries whose credit may not be readily accepted in the beneficiary’s country. In such a case, a bank in a third country may be requested to open the LC.
- Reimbursement Credit: When credit is denominated in the currency of a third country, such credit is termed as reimbursement credit. This is in contrast to the applicant’s country or the beneficiary’s country. Sometimes, credits where a paying/accepting/negotiating bank is reimbursed in a manner other than by debit to the Vostro Account of the opening bank, or by credit to the Nostro Account of the paying/ accepting/negotiating bank is reimburse in a manner other than by debit to the Vostro Account of the opening bank, or by credit to the Nostro Account of the paying/accepting/negotiating bank held with the opening bank are also referred to as reimbursement.
- Anticipatory Credit: Payment under a letter of credit is usually made at the post shipment stage.( i.e. on submission of relevant shipping documents. However, under anticipatory credit, payment is made to the exporter at the pre-shipment stage in anticipation of goods and submission of bills at a later a stage. Where the bills are not presented, recovery will be made from the opening bank.
Anticipatory Credit is of Two Types
- Red Clause Credit: – Under the red clause credit, advance payment is made to the beneficiary for purchasing raw materials/processing and /or packing the goods.
- Green Clause Credit: – It provides for payment of advance towards warehousing and insurance charges at the port where the goods are stored pending availability of ship/shipping space.
Others Types of LC
- Standby Letter of Credit: In a standby letter of credit, the credit is payable upon certification of a party’s non-performance of the agreement, of course upon adducing evidence to the effect that payment has indeed been defaulted. Standby LC is mostly used in countries where financial guarantees are prohibited by law, like in the US.
- Transferable Credit: A transferable credit is one, which can be transferred ( i.e. from the First Beneficiary to a Second Beneficiary). It should be noted that such credit can be transferred only once. The second beneficiary cannot in turn transfer the same to a third beneficiary. A transferable credit will be subject to the original terms and conditions of the credit, excepting the amount of credit, unit prices, percentage of insurance terms, period of validity and shipment. According to Article 48(b) of the UCPDC, a credit will be rendered as transferable, only if it is specifically stipulated as such in the credit.
- Back-to Back Credit: This credit is one that is opened against the security of another credit called the main credit. Under this credit, an LC is opened by the buyer in favour of his actual supplier/manufacturer against the security of the main credit. By doing so, the first beneficiary can obtain reimbursement by presenting documents received under back-to-back credit under the main LC.