Types of Documentary Credit Options

There are several types of documentary credit options available, each with its own unique features and benefits.

A Revolving Documentary Credit is a type of documentary credit that allows the buyer to use the credit multiple times, as long as the total amount does not exceed the credit limit.

A Standby Documentary Credit is a type of documentary credit that is issued by a bank or financial institution, and is typically used to guarantee payment for goods or services.

A Revolving Documentary Credit is often used by buyers who need to purchase goods or services from multiple suppliers, as it allows them to use the credit multiple times without having to apply for a new credit each time.

If this caught your attention, see: Back-to-back Letters of Credit

Irrevocable documentary credits are the most common type, offering high security for both buyers and sellers. They stipulate that no amendments or cancellations can occur without the consent of all parties involved.

By default, a credit is irrevocable even if there is no indication to that effect. This is according to the ICC rules covering documentary credits, specifically the UCP 600.

Irrevocable credits can be either confirmed or unconfirmed, and can only be amended or cancelled with the agreement of the beneficiary and, if one is in place, the confirming bank.

Here's a quick summary of the types of documentary credits:

It's worth noting that banks are unlikely to ever confirm a revocable credit, as they do not provide satisfactory security for either the buyer or the seller.

Irrevocable documentary credits are the norm in global trade, and for good reason. They offer a high level of security for both the buyer and the seller.

By default, a credit is irrevocable even if there is no indication to that effect. This means that documentary credits can only be amended or cancelled with the agreement of the beneficiary and, if one is in place, the confirming bank.

A fresh viewpoint: Carbon Credits

Irrevocable letters of credit are more common than revocable ones, and they cannot be modified or revoked without the agreement of all parties involved. This provides a high level of security for both the buyer and the seller.

In fact, the overwhelming majority of credits used in global trade are irrevocable.

Documentary vs. Demand Guarantees are two types of instruments that serve as a bank's obligation to pay against presentation of compliant documents or demands. Both are autonomous, meaning the bank has no interest in the underlying sale or other contract.

Documentary Credits, as we've discussed, are designed to facilitate international trade by providing security for the payment of goods. Demand Guarantees, on the other hand, represent a secondary obligation covering default only, providing security against non-performance.

To obtain payment under a Demand Guarantee, a presentation does not generally include transport documents, and often consists solely of a simple written demand. This is in contrast to Documentary Credits, which typically require a more comprehensive presentation.

On a similar theme: Secured Credit Card Bad Credit with No Security Deposit

The most applicable set of ICC rules for Documentary Credits is UCP 600, while for Demand Guarantees, it is URDG 758. Understanding these rules is crucial for businesses and traders to navigate these complex instruments effectively.

If you're looking to learn more about guarantees, ICC Academy offers introductory and advanced courses on the topic.

Commercial letters of credit are used in international or domestic trade to ensure payment for goods. They're a useful tool when a seller is concerned about the buyer's creditworthiness.

They're often referred to as documentary letters of credit or documentary credits. This type of letter of credit serves a specific purpose and is different from standby letters of credit.

Commercial letters of credit are used as a method of payment under contracts of sale. They provide a secure way for sellers to receive payment from buyers.

They're particularly useful in cases where the seller is unsure about the buyer's jurisdiction. This can help mitigate risks associated with international trade.

Commercial letters of credit are a type of letter of credit that's often used in relation to the movement of goods. They're a key component of international trade and commerce.

Intriguing read: Trade Finance Fund

A confirmed documentary credit adds an extra layer of security for the seller, relying not only on the issuing bank's credit but also on the assurance of payment from the confirming bank.

This type of credit is suitable when the beneficiary doesn't trust the other party's bank, as it provides a secondary guarantee of payment.

The confirming bank's irrevocable undertaking to honour or negotiate documents without recourse is a key feature of confirmed credits.

You might like: Capital Account in Balance of Payment

Confirmed documentary credits offer an extra layer of security for the seller, as they involve the addition of a confirmation by a bank other than the issuing bank.

This confirmation serves as a secondary guarantee of payment, giving the seller assurance that they will receive payment even if the issuing bank is unable to honour its undertaking.

A confirmed letter of credit is typically requested by the beneficiary when they have concerns about the risk of the issuing bank, country risk, or documentary risk.

Suggestion: Financial Account of Balance of Payment

The confirming bank's irrevocable undertaking to honour or negotiate documents complying with the terms and conditions of the credit adds an extra layer of security for the seller.

A beneficiary will usually request confirmation when they have concerns about the issuing bank's ability to honour its undertaking, country risk, or documentary risk.

Here are some reasons why a beneficiary might request confirmation:

In some cases, a beneficiary might request silent confirmation, a private arrangement between a bank and the beneficiary where the advising bank adds a conditional guarantee of payment without the knowledge of the issuing bank.

However, this arrangement is more costly and not covered by UCP, which can lead to higher risks for the beneficiary.

An unconfirmed letter of credit is only guaranteed by the issuing bank, which means it doesn't involve confirmation from another bank.

This type of letter may be simpler and less expensive for the buyer, but it offers less security for the seller.

The seller then has to rely solely on the creditworthiness of the issuing bank, which may not be sufficient, especially if the seller is unfamiliar with the other parties.

A unique perspective: Commercial Letter of Credit

Usance is a type of documentary credit that allows for delayed payment. Under usance credits, the issuing bank undertakes to honour a compliant presentation at a future date, known as the "maturity date".

There are two types of usance credits: Acceptance credits and Deferred payment credits. Acceptance credits stipulate the presentation of a bill of exchange, or "draft", which the bank will accept and pay at maturity to the beneficiary.

Here's a breakdown of the two types of usance credits:

Red and Green Clause letters of credit offer special financing options for sellers. These clauses allow the seller to draw on the credit before shipping goods and presenting documents.

A Red Clause letter of credit provides an advance payment to the seller, often referred to as a "red clause advance." This advance payment can be used to finance production or purchase of goods for export.

Red Clause letters of credit are particularly useful when the seller needs funds upfront to fulfill an order, such as when buying rare and expensive raw materials.

There are different types of Red Clause letters of credit, including Unsecured or Clean Red Clause and Secured or Documentary Red Clause.

A Green Clause is another type of special clause that allows the seller to draw on the credit before shipping goods and presenting documents.

Here are the different types of special clauses mentioned:

Standby letters of credit (SBLCs) are used to support an applicant's performance obligations or guarantee their financial obligations to the beneficiary. They can also be used to guarantee the performance of a commercial contract.

SBLCs are akin to guarantees since the beneficiary can draw on them in case of the applicant's default or non-fulfilment of contractual obligations. This typically requires supporting documents such as a statement confirming the applicant's default, copies of unpaid invoices, or copies of transport documents.

There are two types of advance payment credits: Red clause documentary credits and Green clause documentary credits. Both allow the beneficiary to draw for up to a specified amount at the pre-shipment stage, but Green clause documentary credits also include additional coverage of pre-shipment warehousing and insurance costs.

Here are the key differences between Red and Green clause documentary credits:

Revocable letters of credit are not commonly used due to their restrictive nature. They allow the issuing bank to modify or cancel the credit without the beneficiary's consent.

These types of letters are contractually legal, giving the issuer significant leverage in the exchange. They can amend or cancel the credit at any time, without needing the beneficiary's agreement.

The Uniform Customs and Practice (UCP) has no provision for revocable letters of credit, making them less appealing to beneficiaries.

Standby letters of credit are used to support an applicant's performance obligations, guarantee financial obligations, or ensure the performance of a commercial contract. They're commonly used in construction projects, international trade, and commercial transactions.

These credits are akin to guarantees, as they're not expected to be drawn on. However, if the applicant defaults or fails to fulfill its contractual obligations, the beneficiary can draw under the standby letter of credit by claiming on the issuing bank or confirming bank.

Broaden your view: Commercial Credit Cards

Standby letters of credit are often used to support open account transactions where a seller ships goods directly to the buyer, and the buyer is expected to make payment directly to the seller. If the buyer fails to pay when due, the beneficiary can draw on the standby letter of credit.

The beneficiary's claim must be supported by documents such as a statement confirming the applicant's default, copies of unpaid invoices, or copies of transport documents as required in the standby letter of credit.

The International Standby Practices of 1998 (ISP98) provides a separate set of rules governing standby letters of credit issued subject to ISP98. This is distinct from UCP 600, which is used for documentary credits but has limited applicability to standby letters of credit.

A revolving letter of credit is used for multiple shipments over a specified period, allowing the buyer to make multiple drawdowns up to a predetermined limit.

This type of letter is useful for ongoing business relationships where there are frequent transactions between the buyer and the seller, with a certain standard of higher trust involved.

Revolving letters of credit simplify the payment process by eliminating the need to open a new credit for each shipment, making them more convenient and efficient.

The parties can agree to stipulate the number of times, the maximum amount, or the latest date up to which a revolving credit will automatically be reinstated.

Here are some key aspects to consider with revolving credits:

A revolving credit is essentially a revolving letter of credit, used for multiple shipments over a specified period, allowing the buyer to make multiple drawdowns up to a predetermined limit.

This type of credit is useful for ongoing business relationships where there are frequent transactions between the buyer and the seller, with a certain standard of higher trust involved.

Red Clause documentary credits are a special type of credit that allows the seller to receive partial payment in advance of shipment. This advance payment, often referred to as a "red clause advance", can be used by the seller to finance the production or purchase of goods for export.

Red clause documentary credits are typically used in situations where the seller requires funds upfront to fulfill the order, such as when purchasing rare or expensive raw materials.

The red clause advance can be released by the nominated bank at the pre-shipment stage, allowing the seller to draw on the credit and use the funds to procure the necessary materials or complete the production process.

Historically, this clause was written in red ink, hence the name "red clause."

Back to Back is a type of documentary credit that's commonly used by traders who act as middlemen between the source supplier and the final buyer.

This process involves two separate credits: a Master Credit in favor of the middleman, and a Back-to-Back Credit in favor of the source supplier.

The terms and conditions of the Back-to-Back Credit are similar to those of the Master Credit, except for a few key differences, including the credit amount, unit price, expiry date, latest shipment date, and presentation period.

Care should be taken when being involved in this type of transaction, as there may be differences of opinion between each bank as to interpretation of terms and conditions.

The ICC Commercial Standards are a set of standard rules and practices for commercial letters of credit. They are developed by the International Chamber of Commerce (ICC) to govern letters of credit.

The key publications for commercial letters of credit are the Uniform Customs and Practice (UCP) for Documentary Credits and the International Standard Banking Practice for the Examination of Documents under Documentary Credits.

The UCP is a set of standard terms and conditions that can be incorporated into a letter of credit if the parties concerned wish to use them. It is internationally recognized but does not have the force of law.

The provisions of the UCP are not automatically incorporated into a letter of credit. They must be expressly incorporated otherwise they will not apply.

The ICC has developed these standards to provide a framework for commercial letters of credit.

For another approach, see: Which of the following Is Not a Type of Galaxy?