Corporate Finance

Analysing the Types of Letter of Credit (LC)

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by

Habib
in

There are several types of letters of credit (LOCs) commonly used in international trade transactions in UAE. Here are some of the most common types:

  1. Revocable Letter of Credit: This type of LOC can be changed or canceled at any time by the buyer or their bank, without the seller’s approval. However, this type of LOC is rarely used because it does not provide sufficient protection for the seller. Example: A UAE buyer applies for a revocable LOC to import goods from a foreign supplier. However, the supplier is hesitant to accept a revocable LOC as it can be canceled without their approval.
  2. Irrevocable Letter of Credit: This type of LOC cannot be changed or canceled without the agreement of all parties involved. It provides more security for the seller than a revocable LOC. Example: A UAE buyer applies for an irrevocable LOC to import goods from a foreign supplier. The supplier is more comfortable with an irrevocable LOC as they can rely on the payment guarantee.
  3. Confirmed Letter of Credit: This type of LOC involves a second bank (usually in the seller’s country) that adds their confirmation to the LOC. This provides additional protection for the seller, as they can rely on the payment guarantee of both banks. Example: A UAE buyer applies for a confirmed LOC to import goods from a foreign supplier. The supplier is more comfortable with a confirmed LOC as they have the guarantee of both banks.
  4. Standby Letter of Credit: This type of LOC is used as a backup payment method in case the buyer does not fulfill their obligations under the contract. It is similar to a guarantee, as it guarantees payment to the seller if the buyer defaults. Example: A UAE buyer applies for a standby LOC to import goods from a foreign supplier. The supplier is more comfortable with a standby LOC as it guarantees payment if the buyer defaults.
  5. Transferable Letter of Credit: This type of LOC allows the beneficiary (usually the seller) to transfer all or part of the proceeds to another party, such as a subcontractor or supplier. Example: A UAE buyer applies for a transferable LOC to import goods from a foreign supplier. The supplier can transfer part of the proceeds to their subcontractor who is manufacturing the goods.
  6. Revolving Letter of Credit: This type of LOC allows the buyer to make multiple shipments or transactions within a specific time frame, without the need to apply for a new LOC each time. Example: A UAE buyer applies for a revolving LOC to import goods from a foreign supplier multiple times over a period of six months. This saves time and effort for the buyer as they do not have to apply for a new LOC each time.