Letters of Credit: Variations

The flexibility of the letter of credit is one of its great strengths. The basic sight letter of credit can be modified in a number of ways to fit the needs of the customer.

Letters of credit may be either revocable or irrevocable, but the letter is used more frequently. The revocable letter of credit carries a risk to the seller. It may be amended or cancelled at any moment without prior notice to the beneficiary. The irrevocable letter of credit can neither be amended nor cancelled without agreement of all parties.

Letters of credit may call for drafts payable after a specified number of days after sight. The documents are prepared by the shipper exactly as before, except that now he draws the usance draft payable, for example, at ninety days after sight. This arrangement has been previously agreed at the buyer’s request and is indicated in the underlying contract and letter of credit application. The documents are negotiated, but instead of paying the seller, the bank accepts the draft – thus making it a banker’s acceptance – and returns it to the seller. He may hold it until maturity and then present it to the bank to receive the full amount; or he may sell it in the current market for banker’s acceptances, receiving a discounted amount.

Such usance letters of credit enable the buyer receive financing. He obtains the documents immediately upon negotiation from the bank by signing a trust receipt. He does not have to pay for the merchandise until the specified time has elapsed.

In some instances, the seller may be forced to meet competition by offering credit terms for as long as several years. This is particularly true for large capital goods equipment, such as electric generators. With a deferred letter of credit, the documents are forwarded to the importer’s bank, while a sight draft is presented at a later date. This gives the importer the opportunity to clear the goods prior to paying for them. In this case the seller is financing the buyer, but he still knows that the opening bank will pay upon future presentation of the draft. Normally, deferment would not exceed a period of one year.

The red clause letter of credit derives its name from the old custom of writing this particular clause in red ink to make it more noticeable. It is often used when the letter of credit is opened by the importer in favour of his agent. For example a United States importer may have an agent in Philippines who will purchase copra from various farmers and then ship it. The agent needs cash to purchase the crop. The importer requests in his application that the letter of credit contains a clause (the red clause) permitting the agent to draw funds from a Philippine bank that are guaranteed by the importer through his bank. The agent can take the letter of credit to the Philippine bank and draw funds by signing a receipt, which the local bank forwards to the United States bank for reimbursement. When the agent has shipped the copra, he presents the required documents to the Philippine bank for a normal drawing by way of drafts from which the amount of the advance is deducted. The advantage of this red clause, of course, is that it is a simple device enabling an agent to draw the necessary funds in advance of the shipment.

A letter of credit may be utilized only by the named beneficiary. There are instances, however, when the importer instead wishes to make the letter of credit transferable to another person or company to be designated by the original beneficiary. The importer instructs the opening bank to prepare a transferable letter of credit addressed to the beneficiary “and/or transferee”; the beneficiary may then negotiate with a supplier and then notify the bank that he has transferred it to yet another specified party. Then the bank accepts drafts, invoices, and other documents drawn by, or in the name of the new beneficiary. If the opener wishes to permit the beneficiary to transfer the letter of credit to more than one party, the opening bank issues the letter of credit to the named beneficiary “and/or transferee’s”. Each can utilize only a portion of the letter of credit, so that the total drawings do not exceed the maximum amount. This kind of letter of credit also allows partial shipments.

The revolving letter of credit is used when a series of identical shipments is made over a fixed period of time, such as monthly. The opening bank might prefer to open a letter of credit for each shipment. However to avoid issuing a new letter of credit each month, the bank may include a proviso in the original letter of credit that permits the letter of credit to be reinstated once the opening bank notifies the beneficiary. When the bank has paid, and has been reimbursed by its customer, the importer, the revolving letter of credit is reinstated by the opening bank with a new shipping date.

The back-to-back letter of credit is considerably more complex. It is actually two letters of credit that are identical, except for the amounts. The first letter of credit is usually opened in favour of an agent, who then obtains a second letter of credit from his bank by depositing the first letter of credit. He also gives his bank advance invoices and a draft. When the beneficiary under the second letter of credit draws the specified amount, the second bank substitutes the invoices and draft in its possession. Leaving all the other documents exactly as they are, it draws on the first letter of credit to reimburse itself for the payment it has made. Any slight difference in the amounts reflects the agent’s fee. Such back-to-back letters of credit may be used to shield the identity of the ultimate buyer or to comply with regulations of foreign countries. Ultimately, this letters of credit permit an intermediary to utilize the credit standing of the principal for a specific transaction.

Occasionally, the bank is requested by a desirable customer to issue a traveler’s letter of credit, sometimes also called a circular letter of credit. This simply provides a traveler with access to large sums as he makes a trip. The only document required is a draft drawn by him. This kind of the letter of credit is in much less demand these days because most people prefer the convenience of traveler’s checks and credit cards.

The standby letter of credit is not used to cover a specific shipment. Instead, it is utilized in the event that a third party does not do something. For example, it may be used in a place of a bid bond or a performance bond, in a construction project, or perhaps to guarantee the repayment of a third party’s promissory note. A foreign subsidiary of a United States company may desire to borrow from a foreign bank. The foreign bank may require the United States parent company to guarantee that if the subsidiary does not pay its loan at maturity, the foreign bank can draw on a United States bank that has opened a standby letter of credit on behalf of the parent company. When establishing a standby letter of credit, the United States bank should not become involved in any dispute concerning performance or quality of workmanship. The standby letter of credit should be very simple and, in the above example, should require only a sight draft and a statement by the foreign bank that it was not paid.

Because of the many recent abuses in the handling of standby letters of credit, United State banks are now required to include the totals of standby letters of credit with other forms of customer debt in determining the bank’s legal lending limit to the customer.

All the letters of credit discussed so far are examples in which a United States bank opens a letter of credit on behalf of one of its local customers. These can be broadly described as import letters of credit.

Many foreign banks are not well known internationally. Because of this, a foreign bank usually sends its letters of credit through a United States bank – rather then directly to the beneficiary – and asks the United States bank to advise or confirm them. This results in advised letters of credit and confirmed letters of credit.

When the foreign bank asks the United States bank to advise their letter of credit, the United States bank verifies the authenticity of the signatures of the opening bank from its signature book and perhaps answers any questions about the bank that the exporter may have. This is, however, merely a courtesy to the correspondent bank, and it conveys no commitment on the part of the United States bank to pay drafts.

When a letter of credit is confirmed, all of the risks of the issuing bank are then borne by the confirming bank for a fee. If the foreign bank should go out of business, the confirming bank is still obligated to honour the drafts. However, because major international banks in the United States and elsewhere encourage international trade and are quite knowledgeable about the financial soundness of smaller banks, major banks are very willing to confirm letters of credit as part of their correspondent banking relationships.

Assignments

I. Answer the questions.

1. What is one of great strengths of the letter of credit?

2. What modifications of the basic sight letter of credit can you name?

3. What does the red clause letter of credit derive its name from?

4. Who may a letter of credit be utilized by?

5. When is the revolving letter of credit used?

6. Why is the back-to-back letter of credit considered to be more complex?

7. What is the specifics of the standby letter of credit?

II. Translate the following sentences into Ukrainian. Put questions to any two of them.

1. The basic sight letter of credit can be modified in a number of ways to fit the needs of the customer.

2. With a deferred letter of credit, the documents are forwarded to the importer’s bank, while a sight draft is presented at a later date. This gives the importer the opportunity to clear the goods prior to paying for them.

3. The back-to-back letter of credit is actually two letters of credit that are identical, except for the amounts: the first letter of credit is usually opened in favour of an agent, who then obtains a second letter of credit from his bank by depositing the first letter of credit.

4. Because of the many recent abuses in the handling of standby letters of credit, United State banks are now required to include the totals of standby letters of credit with other forms of customer debt in determining the bank’s legal lending limit to the customer.

5. If the foreign bank should go out of business, the confirming bank is still obligated to honor the drafts.

III. Translate the following sentences into English.

1. Акредитив може бути відзивним чи безвідзивним, але останній використовується частіше.

2. Акредитив з червоною умовою отримав свою назву від давнього звичая писати цю особливу умову червоними чорнилами, щоб зробити її більш помітною.

3. Револьверний акредитив використовується тоді, коли протягом встановленого часового періоду виконується ряд ідентичних поставок.

4. Іноземний банк зазвичай відсилає свої акредитиви через банк США і просить останнього гарантувати чи підтвердити їх, оскільки багато іноземних банків не дуже відомі у світі.

5. Відтоді як акредитив підтверджено, всі ризики банку, який видав цей акредитив, несе банк, який надає підтвердження.

IV. Name the following definitions.

1. The letter of credit, which may be amended or cancelled at any moment without prior notice to the beneficiary.

2. The letter of credit, which can neither be amended nor cancelled without agreement of all parties.

3. With this type of letter of credit, the documents are forwarded to the importer’s bank, while a sight draft is presented at a later date.

4. Letter of credit addressed to the beneficiary

V. Define the following types of letters of credit:

- red clause letter of credit,

- revolving letter of credit,

- back-to-back letter of credit,

- circular letter of credit,

- standby letter of credit,

- advised letter of credit,

- confirmed letter of credit.

VI. Make and fill in the table listing types and main features of letters of credit mentioned in the text.

VII. Find in the text and translate all sentences with Infinitives; define functions of the Infinitives (a subject, attribute, object, adverbial modifier, part of a predicate).

VIII. Make sentences with the Complex Subject / Complex Object basing on the text.

IX. Sum up what the text says about different types of letters of credit.