Who’s Involved: Letters of Credit

• There are three primary parties involved in issuing an LC: the issuing bank, the beneficiary, and the applicant. A fourth party might be the advising, or confirming, bank. A seller (beneficiary) will sometimes require a customer (applicant) to get a letter of credit. When this happens, the applicant calls his banking officer at the issuing bank. The issuing bank is the party that guarantees the financial arrangement between the beneficiary and the applicant. The beneficiary may ask his own banking officer to review the letter of credit. This bank is the advising bank. If the advising bank guarantees a portion of the transaction, it becomes the confirming bank.
  
  

Documentary Letter of Credit

• A documentary LC, used for international transactions, covers only one transaction. Once the terms of the transaction are determined, the bank draws up the LC specifying product description and amount, payment terms and shipment details. A documentary LC is a complex document that must comply with applicable international laws.
  
  

Standby Letter of Credit

• A standby letter of credit is often called a “non-performing” LC. Its purpose is to secure a trade credit line with a company in the event a customer fails to pay. Sometimes this form of LC is used for new customers to establish a payment pattern. In other cases, a standby LC is used for financially struggling customers, when the seller is unwilling to offer trade credit. Standby LCs may be as short as one page, and can be renewed automatically.
  
  

Revolving Letter of Credit

• A revolving letter of credit works with the purpose of limiting the amount the buyer can purchase in one month. Once the amount has been used, the bank restores the original amount. Once the buyer has used as much credit as the bank is willing to offer, the buyer must pay it down to open available credit.
  
  

Back-to-Back Letter of Credit

• This type of letter of credit uses two documents, with one serving as collateral for the other. A back-to-back LC is used when there is a trader, wholesaler, or other type of middleman. A trader will asks his buyer for a letter of credit. The trader then opens a letter of credit in favor of the ultimate supplier, using the first as collateral.