8 types of letter of credit for business owners & traders

06 November, 2023

As a business owner, you function as both a seller and purchaser of goods and services. Letters of credit (LCs) are one of the most common methods of payment for goods in international trade. It is an instrument that helps you get the goods and services needed to continue your business operations & ensures that the goods and services you are offered get sent in a timely manner. Similarly, you would want to make sure that when a client is purchasing goods or services from you, your payment is secured. To meet both ends, you can count on a Letter of Credit (LC). This article will help you understand more about the types of Letter of Credit and how these can help you.

What is a Letter of Credit?

An LC is a contract by which a bank guarantees the seller that the buyer will make the payment for the goods and services. The use of LCs to effect payment is widespread in international trade. This is because they offer security of payment for and receipt of goods to the parties involved in the trade transaction who may be in different countries.

You can choose from the different types of LCs available according to your specific requirements.

What are the different types of Letters of Credit?

The different types of Letters of Credit offered by banks in India are as follows:

1. Documentary
   
   A documentary LC is an obligation by the issuing bank to pay the agreed amount to the beneficiary (usually the seller) on behalf of the applicant (buyer) upon receipt of specified documents.
   
   

2. Sight LC or Usance Credit
   
   A sight LC guarantees the payment once the beneficiary (the party which is about to receive the payment) presents the sight LC to the bank along with any other required documents.
   
   

3. Standby LC
   
   A Standby LC (SBLC) is a type of guarantee issued by the buyer’s bank in favour of the seller. If the buyer fails to pay for the goods and services provided by the seller, the seller will demand the buyer’s bank to step in and make the payment. An SBLC essentially acts as a backup.
   
   

4. Revocable and Irrevocable Credit
   
   With a Revocable LC, the terms and conditions can be changed or cancelled by the bank that has issued the LC. Banks do not need to give any prior notice to beneficiaries before doing so. On the other hand, an irrevocable LC is one wherein the terms and conditions cannot be changed or cancelled; the Issuing Bank is bound by the commitments given in the LC.
   
   

5. Back-to-Back Credit
   
   With this LC, the beneficiary (i.e., the seller) can request their bank to issue an LC on behalf of their supplier on the basis of the export LC received.
   
   

6. Transferable Credit
   
   This is an LC with an added provision permitting the bank to transfer the sum specified by the LC to another party at the request of the original beneficiary.
   
   

7. Revolving LC
   
   A Revolving LC is a single LC that can cover multiple shipments, so the credit can be renewed either as to the amount or as to the time it is available. These are often used where regular shipments are made from the same seller over a period of time.
   
   

8. Confirmed LCs
   
   Confirmation is usually requested if the seller is concerned about the creditworthiness of the issuing bank and/or the buyer’s country risk. The advising bank adds its confirmation to the LC at the issuing bank’s request The advising bank then becomes the confirming bank and undertakes to pay the seller (this is a separate undertaking from the one given by the issuing bank and so offers extra security to the seller).
   
   

What is the difference between a Letter of Credit and a Bank Guarantee?

A letter of credit is written commitment document issued by a bank or other financial institutions to assure payment to seller based on documentary proof that the seller has fulfilled their end of the deal per the LC. Under an LC, the seller gets guarantee on payment of his sale of goods from the buyer’s bank.

With a bank guarantee, the bank offers guarantee to a third party on behalf of their customers. If the customer defaults on their obligations, the bank will assure payment to the third party.

Per Letter of Credit, the bank pays the amount to the third party when appropriate documents are produced to the bank on fulfilment of the contract. However, in a bank guarantee, the beneficiary is paid on non-fulfilment of the contract, per the BG.


​​​​​​​*Terms and conditions apply. The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances.

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