Letter of Credit Types

If you do not have enough funds to engage in trade on your own, or if you need to show a seller you are not a financial risk, a letter of credit may help you make trade arrangements. A letter of credit is a letter issued by a bank to back the importer (buyer). Depending on your situation, you may use one of eight letter of credit types.

Confirmed

In a confirmed letter of credit, both the importer's and exporter's banks back the trade arrangement. The exporter's bank confirms the original letter of credit and will step in to make payments if the importer's bank cannot do so. This is useful when the strength of the issuing bank is weak or not well known.

Unconfirmed (Advised)

An unconfirmed letter of credit is not backed by the exporter's bank; the exporter's bank won't provide funds if the issuing bank cannot do so and accepts no liability. However, the exporter's bank does forward the letter of credit to the exporter to verify the bank's authenticity.

Irrevocable

Irrevocable letters of credit cannot be changed or withdrawn without notification. The issuing bank will make payments on the importer's behalf if the importer cannot, and therefore offers complete protection to the importer.

Revocable

An issuing bank may cancel or change a revocable letter of credit at any time. This creates high risk for the exporter, so exporters and their banks do not prefer this letter of credit type.

Standby

A standby letter of credit arranges for the importer's bank to pay only if the importer's own methods of payment fail. The bank is not liable if the importer can fund the trade on his own, but the fact that the bank is willing to step in if needed looks favorable to the exporter.

Revolving

A revolving letter of credit is reinstated as needed for shipments of the same goods. Either the value or the duration of the letter of credit may be reinstated. A revolving letter of credit is beneficial because it eliminates the need to amend or repeat identical arrangements between the exporter, importer and the importer's and exporter's banks.

Transferable

Exporters may have an issuing bank make payments to one or more third parties under a transferable letter of credit. This is useful when an exporter is acting on behalf of another individual or company -- that is, when a middleman is involved.

Back to Back

A back-to-back letter of credit arrangement uses the letter of credit as security. A second letter of credit is drawn on the exporter in favor of the importer. This places the exporter's bank at increased risk.