Detailed explanation of types of letters of credit and their applications

As one of the important payment tools in international trade, letters of credit can be divided into multiple types according to different standards. Each type of letter of credit has unique functions and application scenarios. This article will analyze the main classifications of letters of credit in detail from multiple dimensions such as whether the bill of exchange under the letter of credit is accompanied by shipping documents, the responsibility of the issuing bank, whether there is another bank to guarantee payment, payment time, and the transfer of beneficiary rights, and introduces Several special purpose letters of credit.

Whether the bill of exchange is accompanied by shipping documents

Documentary letter of credit

Documentary letter of credit refers to a letter of credit that is paid against a documentary draft or only against documents. The documents here include documents representing the ownership of the goods (such as ocean bills of lading) and documents proving that the goods have been shipped (such as railway waybills and air waybills).

Clear letter of credit

A clean letter of credit is a letter of credit payable against a clean check that does not come with shipment. When processing a clean letter of credit, the bank may also require the beneficiary to submit some non-shipping documents, such as invoices or advance payment lists.

Responsibilities of the issuing bank

Irrevocable letter of credit

An irrevocable letter of credit means that once it is issued, it cannot be unilaterally modified or canceled by the issuing bank without the consent of the beneficiary and related parties within the validity period. As long as the documents submitted by the beneficiary comply with the terms of the letter of credit, the issuing bank must fulfill its payment obligations. According to Article 10 of UCP600, banks are not allowed to issue revocable letters of credit.

Revocable letter of credit

Theoretically, there is a revocable letter of credit, that is, a letter of credit that the issuing bank can revoke without the consent of the beneficiary or related parties. However, in practice, “UCP600” prohibits the use of such letters of credit.

Whether it is confirmed by another bank

Confirmed letter of credit

A confirmed letter of credit refers to a letter of credit in which another bank guarantees payment obligations for documents that comply with the terms of the letter of credit. The bank is called the confirming bank.

Unconfirmed letter of credit

If a letter of credit is not confirmed, there will be no confirmation from other banks.

Payment time

Letter of credit at sight

A sight letter of credit requires the issuing bank or paying bank to pay immediately upon receipt of documents that comply with the terms of the letter of credit.

Usance letter of credit

A usance letter of credit allows the issuing bank or paying bank to pay within a specified time after receipt of the documents.

Fake Usance Letter of Credit

Although the fake usance letter of credit is forward in form, in fact the beneficiary can get the money immediately, and the paying bank is responsible for discounting it, and the cost is borne by the issuer.

Can beneficiaries transfer rights

Transferable letter of credit

A transferable letter of credit allows the beneficiary to transfer the rights to the letter of credit to one or more secondary beneficiaries, but only once.

Non-transferable letter of credit

If the letter of credit does not clearly indicate “transferable”, it will default to a non-transferable letter of credit.

Special purpose letter of credit

Red clause letter of credit

The red clause letter of credit allows the issuing bank to pay part of the money in advance to the seller after receiving the documents, which is suitable for manufacturing industries.

Revolving letter of credit

After the revolving letter of credit is used, the original amount can be restored and continued to be used, which is suitable for even delivery in batches. There are three recovery methods: automatic, non-automatic and semi-automatic.

Folio letter of credit

A folio letter of credit involves two interrelated letters of credit, and is mostly used for barter trade or processing of supplied materials.

Back-to-back letters of credit

Back-to-back letters of credit require the beneficiary to request the advising bank or other bank to issue a new letter based on the original letter, which is used to resell other people’s goods or when direct trade between the two countries is impossible.

Advance letter of credit/packaged letter of credit

An advance letter of credit allows the issuing bank to authorize the paying bank to advance a portion of the letter of credit amount to the beneficiary in order for it to prepare the goods.

Standby letter of credit

A standby letter of credit is a commercial paper letter of credit or a guaranteed letter of credit. When the applicant fails to perform its obligations, the beneficiary can obtain repayment by submitting a certificate of default.