Understanding the Different Types of Letter of Credits

September 6, 2019

When preparing for a trade deal with a foreign partner, many people seek to acquire a letter of credit. This letter of guarantee is issued by a financial institution on behalf of the buyer. It may be sent to the vendor’s own financial institution or to the seller themselves. It ensures the seller is paid for their goods, as long as they are able to meet certain requirements outlined by the letter. There are four types of letters of credit, each of which is appropriate in its own situation. While they may seem difficult to understand at first, they can all be easily mastered with a little bit of help. Allow us to be that help.

Confirmed Letter of Credit

Understanding the Commercial Letter of Credit

Many people who consider pursuing a letter of credit often abandon the idea when they come across the term “commercial letter of credit”. Being unfamiliar with this phrase, they tend to be intimidated and believe the entire concept of a letter of credit to be too complex to be worth pursuing. In reality, the commercial letter of credit is exactly the same as the traditional letter of credit. It is just another name for the letter of credit discussed above and should not inspire any fear or confusion in potential foreign buyers.

Understanding the Confirmed Letter of Credit

If a vendor is issued a letter of credit from a foreign bank or other financial institution which they are not well-known with, they may understandably be skeptical of the issuer’s ability to honor its contents. In such a situation, the seller may ask for the letter of credit to also be signed by a financial institution they are more trusting of. When this happens, the letter of credit can be classified as “confirmed”, as is the issuer’s ability to pay for the goods in question.

Understanding the Irrevocable Letter of Credit

For a while, there was some talk of “revocable letters of credit”. In theory, a revocable letter of credit would allow the buyer or the buyer’s financial institution to change the terms of the deal without notifying the seller. This, of course, is entirely unfair to the seller and would make many foreign sellers reluctant to accept any letter of credit. Thankfully, the revocable letter of credit no longer exists. All letters of credit now are considered irrevocable and require authentication before they can be altered or canceled.

Credit for Company

Understanding the Revolving Letter of Credit

Once a letter of credit has been used between two parties effectively, they may agree to work from a revolving letter of credit going forward. A revolving letter of credit can be used for multiple transactions, eliminating the need to draw up a new one each time a purchase has been made. The typical revolving letter of credit has an expiration date of some kind, but the exact date will vary from letter to letter. In most cases, a revolving letter of credit can be relied upon for up to one year.