Types of Letters of Credit.

Traveler´s letters of credit, which were commonly used in eighteenth century, were the first financial instrument contains very similar characteristics with the contemporary letters of credit. From traveler´s letters of credit days to today´s complex global economy, the letters of credit have been performing their duties as a secure and reliable payment method. Actually, during this period letters of credit have gained a very flexible structure that can satisfy different needs of different types of international trade practitioners. In this article, we will discuss types of letters of credit.

Commercial Letters of Credit.

Commercial letters of credit are mainly used as a primary payment tool in international trade such as exporting and importing transactions. Majority of commercial letters of credit are issued subject to the latest version of UCP (Uniform Customs and Practice for Documentary Credits). The ICC publishes UCP, which are the set of rules that governs the commercial letters of credit procedures.

Standby Letters of Credit.

Commercial letters of credit are a means of payment to be utilized when the principal perform its duties. As an example, let us consider an exporter who ships the goods according to the sales contract and apply to the nominated bank for the payment. If the nominated bank decides that the presentation is conforming to the terms and conditions of the credit and the UCP rules then exporter will be paid. This situation is just contrary in standby letters of credit. A payment is made to the beneficiary of a standby letter of credit when there is a breach of the principal's obligation. As an example, let us consider a construction company that has been awarded with a tender. If this construction company cannot fulfill its obligations under the project contract beneficiary of the standby letter of credit can apply to the nominated bank for the payment. However, the nominated bank considers only the terms and the conditions of the standby letter of credit and the rules governing the credit when deciding a complying presentation. One point that needs to be stressed is that standby letters of credit have their own rules, which are called The International Standby Practices 1998 (ISP98). They are also published by ICC. However, a standby letter of credit can be issued subject to either the UCP or the ISP.

Revocable Letters of Credit.

Revocable letters of credit give issuer the amendment or cancellation right of the credit any time without prior notice to the beneficiary. Since revocable letters of credit do not provide any protection to the beneficiary, they are not used frequently. In addition, UCP 600 has no reference to revocable letters of credit. All credits issued subject to UCP 600 are irrevocable unless otherwise agreed between the parties.

Irrevocable Letters of Credit.

Irrevocable Letters of Credit cannot be amended or cancelled without the agreement of the credit parties. Unconfirmed irrevocable letters of credit cannot be modified without the written consent of both the issuing bank and the beneficiary. Confirmed irrevocable letters of credit need also confirming bank's written consent in order any modification or cancellation to be effective.

Unconfirmed Letters of Credit.

Unconfirmed Letters of Credit can be described as a letter of credit, which has not been guaranteed or confirmed by any bank other than the bank that opened it. In these types of credits, the only bank that undertakes to honor a complying presentation is the issuing bank.

Confirmed Letters of Credit.

It would be easier to understand the confirmed letters of credit if we start from the definition of the confirmation.

Confirmation means a definite undertaking of the confirming bank, in addition to that of the issuing bank, to honor or negotiate a complying presentation.

If a letter of credit's payment undertaking is guaranteed by a second bank, in addition to the bank originally issuing the credit this kind of credit is called confirmed letter of credit. The confirming bank agrees to pay or accept drafts against the credit even if the issuer refuses to do so. Only irrevocable credits can be confirmed.

Clean Letters of Credit.

Clean letters of credit are issued only by the request of the highest credit standing companies. It is suitable for variety commercial situations where no movement of goods is expected. Historically these types of credits have been used in traveler's letters of credit. Today direct pay standby letter of credit can be given as an example of clean letters of credit.

There are also some other form of letters of credits which deserve special attention. We will discuss them by one by more in detail however; you can find short description of each of them below.

Transferable Letters of Credit.

Transferable letter of credit is a documentary credit that is issued with the option to allow a trader to transfer its rights and obligations to the supplier.

Back-to-Back Letters of Credit.

Arrangement in which one irrevocable letter of credit serves as the collateral for another; the advising bank of the first letter of credit becomes the issuing bank of the second L/C. Unlike transferable letters of credit, there are two separate letter of credits exist in back-to-back letter of credit transactions.

Advance Payment (Red Clause) Letters of Credit.

Letter of credit that carries a provision (traditionally written or typed in red ink) which allows a seller to draw up to a fixed sum from the advising or paying-bank, in advance of the shipment or before presenting the prescribed documents.