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The letter of credit is a payment tool that can be used to finance both make domestic and international purchases. There are many different types of letters of credit.
What is a letter of credit?
A letter of credit is basically a payment order in the name of a buyer or importer for the bank to pay for the goods or goods that the bank is purchasing from a seller or exporter, which is the beneficiary of the letter of credit. In this way, the payee secures his/her payment, and the customer uses the bank as an intermediary for the transaction.
Types of letter of credit
Now that we know what a letter of credit is, let’s see what types of letters there are:
Acceptance letter of credit: This is a type of “signature credit” and is given as long as the letter of credit is confirmed and irrevocable.
Trading credit: Through this letter of credit, the issuing bank undertakes to pay that letter of credit and the respective letters to any bank that submits them.
Transferable credit: This letter grants the beneficiary the possibility of passing the open credit in their favor to one or more beneficiaries.
Revocable letter of credit: This type of letter of credit allows the bank to modify or cancel the credit at any time before it has been used by the beneficiary, so it represents some degree of insecurity for the seller.
Irrevocable letter of credit: This type of letter of credit cannot be modified or canceled and presupposes an unbreakable commitment between the issuer and the beneficiary, making it much safer for the issuer.
Confirmed letter of credit: This letter of credit is issued by one bank and confirmed by another, so it acts as collateral, so it is also an irrevocable letter of credit. In this case, the confirming bank is liable to the beneficiary under the terms of the issuing bank from the date the confirmation was delivered.
Credit in sight: This letter of credit is filed to support a spot sale purchase and operates only with the submission of the shipping documents, as specified in the contract.
Derivative credit or “Back to Back”: This letter of credit is a transferable type of credit. It is an open credit to the beneficiary which in turn constitutes a guarantee of another credit ordered by the beneficiary and in favor of a third party.
Revolving Credit: This letter of credit is used when the buyer makes periodic transactions, so that the bank agrees to pay for each of the seller’s dispatches without requiring the payee to request payment for each new shipment. This letter of credit is presented under two systems:
Auto-renewal: In this mode, the bank pays the full value of the credit automatically until the credit is consumed.
Conditional renewal: The bank undertakes to pay for each firm. However, in case of non-compliance, the bank can refuse to renew the payment of the firms, so this modality represents a greater risk to the seller.
A final word
A letter of credit is a means of payment and/or financing by which a customer requests an order from the bank to pay a certain creditor in such a way that the creditor secures his/her money and delivers the corresponding goods. In addition, each transaction has a letter of credit type so the payer can order both payment and financing letters of credit for different sellers, provided that the bank approves issuance of such a letter of credit.
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