Last updated: February 15th, 2020 11:49 AM

Types of Letter of Credit

A letter of credit is an assured form of payment which is widely used by businesses in trade transactions. In a Letter of Credit (LC) transaction, a bank undertakes to make payment to a seller or beneficiary on submission of documents stipulated in the LC. In this article, we look at the basics of a Letter of Credit (LC) transaction and types of letter of credit.

Basics of a Letter of Credit Transaction

Applicant: The applicant in an LC transaction is usually the buyer or importer of goods. The applicant of the LC has to make the payment if documents, as per the conditions of the LC are delivered to the Bank.

Beneficiary: The beneficiary is the party to whom the LC is addressed, i.e., the seller or exporter. The beneficiary would receive payment from the nominated bank against submission of documents as per the LC condition.

Issuing Bank: The issuing bank is the Banker to the importer or buyer which lends its guarantee or credit to the transaction. The issuing bank is liable for payment once the documents as per the conditions of the LC that receives from the Negotiating Bank.

Negotiating Bank: The Negotiating Bank is the beneficiary's bank. The beneficiary in an LC transaction would be the seller or exporter. The negotiating bank would claim payment from the issuing bank or the opening bank.

Types of Letter of Credit

There are various types of Letter of Credit in international transactions.

DA (Usance) or DP LC: A DA LC is a type of letter of credit wherein the payment is to be made on the maturity date in terms of the credit. The documents of title to goods are delivered to the buyer merely on acceptance of documents for payment. The buyer would then make the payment on the due date of the maturity of the LC. DP LCs are types of letter of credit wherein it pays against documents on presentation.

Irrevocable & Revocable LC: Irrevocable letter of credit is a type of LC which can be cancelled or amended only with the consent of the beneficiary, applicant and confirming bank. A revocable LC can be cancelled or amended at any time without prior intimation to the beneficiary. LCs are normally irrevocable.

LC With or Without Recourse: If the beneficiary holds itself liable to the holder of the bill if dishonoured, then the LC is considered with recourse. Where the beneficiary doesn't hold itself liable, the credit is said to be without recourse.

Restricted LC: A restricted LC is one wherein it designates a specific bank to pay, accept or negotiate the LC.

Confirmed LC: A confirmed LC is a type of letter of credit in which the advising bank at the request of the issuing bank adds confirmation that payment will be made. The confirming bank's liability is similar to the issuing bank. The confirming bank has to honour the payment if tendered by the beneficiary.

Transferable LC: If an LC can be transferred by the beneficiary in whole or in part to a second beneficiary (usually a supplier to the seller) then the LC is a transferable LC. The 2nd beneficiary, however, cannot transfer the LC further.

Back to Back LC: In a back to back LC, a 2nd LC is opened by the original beneficiary in favour of the 2nd beneficiary against the security of the original LC. In general, a back to back LC is in open for the suppliers.

Standby LC: A standby LC is similar to performance bond or guarantee, but issued in the form of an LC. The beneficiary of a standby LC can submit a claim by means of documentary evidence, as stipulated in the LC document.

Revolving LC: In a revolving LC, the applicant is able to use the LC facility again based on drawings made and payment made against the LCs.