Types of LC

A letter of credit is an important financial tool in trade transactions for both domestic as well as international market. There are various types of letter of credit (LC) used in trade transactions between buyers and sellers. As an apparel exporter one should understand all the different types of L/C to pick one which serves the purpose. Some of them are defined below.

1.  Import/export

The same credit can be termed an import or export letter of credit depending on whose perspective it is considered. The exporter will term it as an export letter of credit whereas an importer will term it as an import letter of credit.

2.  Revocable LC

A letter of credit is said to be revocable which can be canceled or amended by the issuing bank at any time for any reason without prior notice to or consent of the beneficiary. From the exporter’s point of view, such LC is not safe. All credits issued subject to UPC 600 are irrevocable unless otherwise specified.

However, if any bank has negotiated the bills before receipt of notification of revocation, issuing bank is liable to honor its commitments.  

3.  Irrevocable LC

Unlike revocable LC, a letter of credit is said to be irrevocable which can’t be canceled or amended without the consent of all parties involved.

Any changes or cancelation of such LC is done by the applicant through the issuing bank must be authenticated and approved by the beneficiary. From the exporter’s point of view, such LC is safe.  

4.  Confirmed LC

A letter of credit is said to be confirmed to which another bank called confirming bank usually advising bank has added its confirmation to make payment even if the issuing bank fails to make it.

A confirmed LC is used when the creditworthiness of issuing bank is questionable and seller seeks to get a second guarantee to assure payment. So a confirmed LC provides more security than an unconfirmed one.

The bank which adds its confirmation to a credit is desired by the beneficiary from a bank known to him, preferably the one located in exporter’s country so that risk become localized and exporter can deal easily with a local bank rather than deal with a bank abroad which has issued it.

5.  Unconfirmed LC

Unlike confirmed LC a letter of credit is said to be unconfirmed which has not been guaranteed by any bank other than issuing bank that only responsible to make payment.

Since unconfirmed LC is guaranteed only by the issuing bank so it is less secured than a confirmed one.

6.  Sight Payment LC

A letter of credit is said to be sight payment LC for which payment is made immediately by the issuing bank against the presentation of required document.

As an apparel exporter we always expect sight LC from our buyer.

7.  Deferred Payment LC

Unlike sight LC, a letter of credit is said to be deferred payment LC for which payment is not made immediately by the issuing bank against the presentation of required document but a respective future date defined in letter of credit. A deferred payment LC also called usance letter of credit.    

As an apparel exporter we don’t expect deferred payment LC from our buyer but as an importer of raw materials we should provide it to our suppliers.   

  

8.  Transferable LC

A letter of credit is said to be transferable LC which can be transferred in whole or in part by the first beneficiary to one or more second beneficiaries.

Transferable LC is suitable for triangle trade where a middleman exist between the buyer and seller. A transferable LC issued in favor of the middleman then the middleman transfer the whole or part of the credit to the ultimate supplier of the goods.

9.  Non transferable LC

Unlike transferable LC a letter of credit is said to be non transferable which can’t be transferred in whole or in part by the first beneficiary to one or more second beneficiaries.  

10.   Back-to-Back LC

A letter of credit is said to be a back-to-back LC which is opened on the strength of and backed by another LC. There are two separate credits are simultaneously exist in a back-to-back letter of credit transaction to facilitate intermediary trade. The first one is issued by buyer in favor of the intermediary then the intermediary issues the second one in favor of the ultimate supplier of the goods.

Back-to-back LC may be used when an intermediary is involved but an export LC is unsuitable to transfer.

Back to Back LC in Perspective of Bangladesh

In the perspective of Bangladesh, a back-to-back LC is one which is issued on behalf of an export oriented industrial unit against the security of an export LC for procurement of raw materials either locally or from abroad.

Back-to-back LC is subject to observance of domestic value addition requirements prescribed by the ministry of commerce from time to time. To open back-to-back LC issuing bank requires no margin but keeps the export LC lien with the bank.

A back-to-back LC is a Triangle of Trust among the parties including the garments factory, the fabric & accessories supplier, and the bank. Thus, with the help of back-to-back LC a garment factory can works without working capital.   

Bangladesh Bank’s Instructions to Open of Back to Back Import LC

The following instructions should be complied with while opening back to back import LCs

(i)   Only recognized export oriented industrial units operating under bonded warehouse system will be allowed the back-to-back LC facility.

(ii)  The master export LC (against which opening of back-to-back LC is requested) should have validity period adequate to cover the time needed for importation of inputs, manufacture of merchandise and shipment to the consignee.

(iii)  The back-to-back LC value shall not exceed the admissible percentage of net FOB value of the relative master export LC.

(iv)  The back-to-back import LCs shall be opened on usance basis for a period not exceeding 180(one hundred eighty) days. Interest for the usance period shall not exceed the LIBOR rate.

(v)   All amendments of the master export LC should be noted down carefully to rule out chances of excess obligation under the back to- back import LC.

(vi)  Back-to-back import LC should not be opened against LCs received for export under Barter/STA, without prior approval of Bangladesh Bank.

In trade, barter is a system of exchange where participants in a transaction directly exchange goods or services for other goods or services without using a medium of exchange, such as money.