Type of Letter of credits ( LC ) used frequently

Updated: Apr 15


What is #SWIFT


SWIFT is an acronym for the Society for Worldwide International Financial Telecommunication organized under Belgian law as a nonprofit cooperative company. It is an international communications system for messages among its member institutions in most of the countries in the Americas, Europe, Japan, and certain countries in Asia. Its member institutions are banking organizations engaged in transmitting international financial messages (and certain non-banking institutions).


A. What Is a #Confirmed Letter of Credit ( #ARDLC)?


The term confirmed letter of credit refers to an additional guarantee to the original letter of credit obtained by a borrower from a second bank. This second letter guarantees that the second bank will pay the seller in a transaction if the first bank fails to do so. Borrowers may be required to get the second letter of credit if the seller has doubts about the creditworthiness of the issuing bank of the first letter. Requiring a confirmed letter of credit decreases the risk of default for the seller.


How Confirmed Letters of Credit Work

Letters of credit are negotiable instruments that are most commonly used in international trade. and in business transactions that require substantial payment for goods or services. Instead of requesting an advance payment, the seller may require the buyer to obtain a letter of credit for the balance of the payment owed at the time of full delivery. This letter acts as a guarantee from the buyer's bank that payment will be made on time and for the full amount. If the buyer fails to live up to their obligation as outlined in the contract, the bank takes on the responsibility of covering the full amount.

The same bank cannot issue the first and confirmed letters of credit.

The seller may require a second letter of credit or a confirmed letter of credit. This second letter requires the backing of more than one bank by a buyer in a domestic or international transaction. A confirmed letter may be required if the seller is not satisfied with the creditworthiness of the first letter of credit. In many cases, the second bank is the seller's bank. When the buyer gets the second letter, it confirms the first one and qualifies it as a confirmed letter of credit. The second bank promises to pay the seller the amount stated if the first bank fails to do so when it issues the confirmed letter of credit.

The process of securing the second letter of credit is the same as the first one. The buyer must find a second bank to back its purchase in case of default. The structuring of the funds for the second letter of credit generally takes the terms of the first letter of credit into consideration as well. In some cases, the seller may only require the second letter of credit represent a percentage of the total due because the sale already comes attached with a credit letter by the first bank.

Just like the first letter of credit, banks may also charge the buyer a fee when they issue a confirmed letter of credit. The amount of the fee may depend on the size of the transaction and payment amount, as well as the relationship between the buyer and the bank. In many cases, they may ask the buyer to put up securities or cash as collateral in exchange for the letter.


KEY TAKEAWAYS

A confirmed letter of credit is a guarantee a borrower gets from a second bank in addition to the first letter of credit.

The confirmed letter decreases the risk of default for the seller.

By issuing the confirmed letter, the second bank promises to pay the seller if the first bank fails to do so.


Special Considerations

Buyers must work with their banks to secure a letter of credit. This requires a full credit application—the same way the buyer would if they applied for a loan. If the bank approves the letter of credit, it documents its willingness to pay the seller the stated amount if the buyer defaults at the time of payment. The terms of the letter typically structure the payment as a loan for the buyer.

If the buyer is unable to make the payment to the seller at the time when the funds are due, the bank issues the payment as a loan to the buyer. The buyer also agrees to the bank’s terms and conditions when they receive the letter. If required, the terms of the loan may include a stated interest rate and payment schedule as well as other disclosures regarding repayment.

If the seller is satisfied with the buyer's first letter of credit they may accept it as an unconfirmed letter of credit. Unconfirmed letters of credit require the support of only one lending bank which means a second or confirmed letter of credit isn't required.


Advantages of Confirmed Letters of Credit

Just like a (first) letter of credit, the confirmed or second letter of credit has advantages for both the seller and the buyer by protecting both their interests. The letter gives the seller assurance that the will receive payment after the goods and/or services are transported to the buyer. As mentioned above, if the buyer doesn't pay, the bank assumes responsibility for the payment. By getting a second letter, the risk of default drops, since another bank agrees to pay if the first one isn't able to do so. Buyers can rest assured that they will receive the requested goods and services from the seller when they obtain a confirmed letter of credit.


Example of Confirmed Letter of Credit

Here's a hypothetical example of how confirmed letters of credit work. Let's say Company A purchases supplies from Company B, which operates in a different country. In order to facilitate the transaction, Company B requires a letter of credit from the buyer's bank. Company A receives this and sends it over to the seller. Because the issuing bank of the first letter of credit is in a different country and its creditworthiness is not known, Company A tells the buyer that it needs a second letter of credit from another bank in order to complete the transaction. The buyer applies for the second letter with the seller's bank. This will likely satisfy the conditions of the sale since Company B already has a relationship with this bank.




B. Is different a transferable letter of credit from a back-to-back letter of credit?


A #transferable letter of credit specifically permits a beneficiary (transferor) to transfer all or some of the rights and protection afforded to it under the letter of credit to a third party (transferee), who then becomes a second beneficiary on the letter of credit.



Transferable letters of credit are typically used in transactions where the first letter of credit beneficiary is a middleman and the second letter of credit beneficiary is the middleman’s supplier.


A #back-to-back letter of credit is a letter of credit (second letter of credit) issued on the basis of an already existing letter of credit (first letter of credit). Generally, the beneficiary on the first letter of credit is the applicant for the second letter of credit.


The purpose of structuring the credits in this manner is to secure the payment to be made under the second letter of credit with the payment made under the first letter of credit.


However, this structure has not always worked as intended and as a result, banks have experienced many problems with back-to-back letters of credit.


Today, back-to-back letters of credit are not offered by many banks and, consequently, are only very rarely used. When available through banks, however, back-to-back letters of credit are used in transactions where the beneficiary on the first letter of credit is a middleman and the beneficiary on the second letter of credit is the middleman’s supplier.


C. Diff of #Stand by letter of credit and #documentary letter of credit


A standby letter of credit is a letter of credit that is issued in favor of the standby letter of credit beneficiary for the purpose of «backing-up» certain specified obligations of the standby letter of credit applicant.




A standby letter of credit requires the beneficiary’s presentation of documents which indicate that the letter of credit applicant has not met the obligations which the standby letter of credit backs-up.


A standby letter of credit, therefore, is not intended to be drawn upon by the standby letter of credit beneficiary unless the standby letter of credit applicant does not meet its obligations as specified by the standby letter of credit.


A #documentary letter of credit (also known as a commercial letter of credit or a merchandise letter of credit) is a letter of credit that is issued for the purpose of making payment to a specified beneficiary if the beneficiary performs as required. Documentary letters of credit are called documentary letters of credit because the banks involved in the letter of credit transaction deal in documents as opposed to goods.


The terms and conditions specified in a documentary letter of credit generally involve the presentation of specific documents within a stated period of time.


The principal difference between a standby letter of credit and a documentary letter of credit is the fact that a documentary is an active payment instrument under which payment is intended if the terms and conditions prescribed by the letter of credit are met, whereas a standby letter of credit is a passive payment instrument under which payment is not intended and will occur only if the standby letter of credit applicant fails to meet its obligations as specified by the standby letter of credit.


D. When confirmed Letter of credit used ?


A confirmed letter of credit is a formal written undertaking issued by a bank in the buyer’s country (issuing bank) and guaranteed or confirmed by a bank in the seller’s country (confirming bank) in accord with which both banks agree to pay a seller (the letter of credit beneficiary) a specified amount on behalf of a buyer (the letter of credit applicant.account party), if the seller complies with the terms and conditions that are specified within the letter of credit.


A confirmed letter of credit is a desirable (albeit expensive) payment method for a company that is buying a product internationally and a desirable (albeit expensive) payment method for a company that is selling product internationally.


The buyer who uses this payment method can feel comfortable that two banks are assessing the seller’s performance under the letter of credit which has been issued on behalf of the buyer. Likewise, the buyer can feel comfortable that the seller will not be paid if the seller does not perform exactly as the confirmed letter of credit requires.


The seller, on the other hand, should also feel comfortable with a confirmed letter of credit transaction in that the seller knows that it will be paid in the U.S. by a U.S. bank if it performs in accordance with the terms and conditions that are specified by the letter of credit.


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