Types of Letter of Credit (LC) - Hindi - YouTube

Subscribe to the Asset Yogi channel and press the bell icon to watch the latest finance videos first

Namashkar, my name is Mukul & welcome to Asset Yogi, Where we unlock the knowledge of finance

In this video, we are going to talk about types of Letter of credit

Watch my last video, in which I have talked about concept of Letter of Credits

By which you can at least understand the mechanism of Letter of Credits

In this video, we will cover all main types of Letter of Credits

and understand their working, and understand the situations in which they are used

This might be a long video, I guarantee if you watch the whole video

Then you will understand all types of Letter of Credits

Let's move towards the blackboard

How many types of Letters of Credit are there & How do they work?

In my last video, I explained the mechanism of how Letter of Credits works & how payments are done?

See my previous Letter of Credits video to understand the mechanism of Letter of Credit

I will do a quick recap,

What happens in an import-export trade is, let's say there is a buyer who ordered some item from abroad

In my last video, I take the example of someone who imports computer equipment from china

So, he buys in Letter of Credit

So, the buyer will go to his bank and request for LC and then the opening or issuing bank

Opening banks further transfer the LC to the advising bank

So, advising bank checks the authenticity of that & sell it to the seller

As soon as the LC reaches to the seller, they ship the goods to the buyer

And also submit the documents such as, bill of lading, etc. to the nominated bank

Nominated bank is basically a nominated bank of issuing bank or we can call it as negotiating bank

These nominated banks & advising banks can be same

As soon as the documents are submitted to the negotiating bank, the beneficiary get their payments

Beneficiary means seller

And then negotiating banks after checking the documents send it to the issuing bank

As per Letter of Credit, shipment are done or not

So, in the Bill of Lading details of goods are written

It sends the document back to issuing bank

Then the document is checked by a buyer after getting approval

The issued bank ordered an applicant to release fund

when the applicant pays to a opening bank

Then opening bank paid to a negotiating bank

It already paid to the beneficiary

In that way, this cycle operates.

This type of Letter of Credit is called a "commercial Letter of Credit"

It is one of the most common Letters of Credit.

It has few conditions, this is for simple trade purposes

It is generally facilitated by a guideline from an international chamber of commerce(ICC)

These guidelines are called Uniform Custom and Practice for Documentary credits

These are conditions for a letter of credits set by ICC

Format of letter of credit is decided according to that

We also called it an import-export Letter of Credit

So here we have done commercial Letter of Credit

Let's move to other types of Letter of Credit

I think you understood this mechanism

Now, what is StandBy Letter of Credit

We have seen that in Normal commercial Letter of Credit

When shipment completes then payment will be made to the beneficiary

But in the case of StandBY, it is converse

In a StandBy LC payment is not made only when shipment is done but,

If there is a breach of any contract then this StandBy LC is opened

E.g. let say a construction company fails to deliver the project on time

Then StandBy L.C is taken from that company

If the company also fails to pay then StandBy LC is opened

So it acts like a bank guarantee

LC opened only when conditions are not met or breach of contract

Otherwise in normal cases applicant or deliver of contact made payment

Basically, it is a backup financial arrangement if a company fails to deliver its obligation

Then this L.C is opened

For StandBy LC, international Standby practices(ISP) guidelines provided by ICC

Another type of LC is Revocable LC

Revocable LC means issuing banks can change or modify the conditions of an LC

OR can cancel it

Without notifying the beneficiary

In these LC interest of the beneficiary is not secured

there is no guarantee of payment

These are not endorsed by UCP

There is no mention of Revocable LC in the guidelines of ICC

It is not used much as the interest of the seller is not secured

Therefore irrevocable LC is widely used

In Irrevocable LC, it neither changed nor be canceled without the agreement of credit parties

Agreement of opening bank and advising bank is required

Also agreement of applicant and beneficiary essential

Irrevocable LC can be changed only when all parties agree to it otherwise not

According to the UCP guidelines, all LC are irrevocable until unless an agreement

If they do not agree in writing, then LC will be recognized as Irrevocable LC automatically

So, these are Revocable and Irrevocable LC's

Next is

Unconfirmed LC

What we talked about in the whole process was about unconfirmed LC

In this the guarantee was fully of issuing bank

So, issuing bank takes the full guarantee that, Let's assume, in the LC

If buyer does the default then too, the issuing bank will do the whole payment

But many-a-times, the credit rating of issuing bank is very low

Maybe the issuing bank can be small, so the beneficiary/seller may not trust them, may say

Then, you can bring the guarantee of a big bank whose credit rating is good

So, confirmed LC is that where a second bank guarantee is also given, i.e. a big bank

The Issuing bank may not be able to make the payment & the buyer also does default, then

Then I will do the payment, for which we take confirmed LC

Generally, this is done when the credit rating of issuing bank is low or it is a small bank,

On which the seller may have trust issues

Only irrevocable LC's are confirmed, the confirming bank will not take guarantee of revocable bank

Next is, Transferrable LC

In the transferrable LC, the seller can transfer their right to any other party

The whole LC or some portion of it can assign our right to any other party

The beneficiary, can be a part of a big company

Then it can happen that, the LC can assign its rights to the holding company

So this type of LC are called transferrable LC, these are generally used when the seller

Is not the sole manufacturer

Maybe they can take some parts from any other manufacturer, so in that case the portion of LC

They will share their rights with other company too

Or the case that I have discussed, that the seller could be a subsidiary company, then it can assign

The right of LC to the holding company

So, this is called the Transferrable letter of credit

Then comes Back to Back LC

Understand it carefully

Let's say, here is a buyer and a seller, the payment's through the LC in buyer's bank & the advising bank

the seller and the LC reaches here

Then the LC reaches the seller, this is a normal trade

Let's assume, the seller is an export house or a trader, it is not a manufacturing unit

It could be that, it is only trading with you, now in this case

It will require payments, maybe it does not have goods immediately

Then what it will do is,

It will go to the seller's bank & say that it is buying the goods from a different supplier

This is a 3rd party

In which there are 3 parties who are trading

And three banks, which means there are a total 6 parties

So, it will say that it is buying goods from a different supplier you give it a back to back LC

Take the current LC as a collateral

And give me a different back to back LC

I am writing BTB for back to back

So now the seller's bank i.e. the advising bank or negotiating bank will assign back to back LC

And pass it to the supplier's bank

And finally, this back to back LC will reach to the supplier

Let's assume

The exporter has sent the goods at $100,000

They are getting it for $70,000 which means they are getting a profit of $30,000

They will say, they are getting the LC of $100,000 here

Then they will say, you give me $70,000 back to back LC, so this is the way BTB works

It is generally used when,

The exporter is a trader or a export house, who don't have its own manufacturing unit

In this case, the seller issues the back to back LC to the supplier and this advising/negotiating bank

Of seller will issue Back to Back LC by keeping the original LC as a collateral

By chance,

If the payment is not done due to any reason, then the seller's bank will recover it from this LC

The amount of back to back LC will be lower than the original LC and the difference is the trader's profit

As we have seen, this LC will be $100.000

And the Back to Back LC will be of $70.000

Because here we have seen the supplier is giving him the goods at $70,000

And he is selling this at $100,000 to the final buyer

So, the remaining $30,000 will be his profit

This is how Back to Back LC works

Now comes the,

Red clause LC

It basically is used for advance payment

Let's say, Buyer gives the normal LC to the issuing bank and then it will go to the nominated bank

Here the payment is not immediate to the seller

Seller says,

He wants an advance payment because he doesn't have goods immediately

Now, for manufacturing, packing, dispatching, shipping of those goods he will need money

He says, give me an LC for advance payment by which he can get some initial payment

Here, issuing bank will say to the nominated bank to give him the advance payment on their risk

Advance allowed by nominated bank of issuing bank to allow advance and is called as RED CLAUSE LC

He gets the payment from here and it is given when

Seller gives a receipt & a written undertaking that he will deliver the documents when he will ship it

So he will deliver these documents and the nominated banks will get their money against these

Nominated bank will surely get the money, because the risk here is taken by the issuing bank

This is also called as unsecured credit

This credit risk is of the issuing bank and here

The buyer is not giving any extra collateral, so the issuing bank is taking the risk

Later, the nominated bank adjust the seller's advance payment from the final LC payment

This is how Red Clause LC works

Then comes, Green Clause LC

It provides Advance payment to the seller for pre-shipment finance & storage at export terminal

Here, the normal LC is there

Besides this, a Green Clause LC is given here

No new LC is issued, it is added in the common Lc

It is written in Green Ink, and is usually used in export of commodities

If a commodity is exported like Iron Ore, Coal, Wheat, Grains, etc.They are stored in the export terminal

Then seller ask for a advance payment

Here the advance payment is done till the storage

Basically, This is a type of secured credit in which the seller has to submit the receipt & written undertaking

with the receipt given from the warehouse

The advance is given after this.

This is a type of secure credit because the goods are sent to the export terminal & the receipt is given

to the Nominated bank

The advance is been adjusted by the nominated bank by the final payment according to the green cause LC

This is the Green Cause LC

Then comes the, Revolving Lc

It is used when similar transactions will happen over a period of time

Same LC (revolving LC) will be used for all transactions

For example,

$100,000 worth of coal is been exported from Australia & is been imported to India for 12 months

The coal is imported from Australia

Of $100,000/month, for 12 months

Here, we don't have to open 12 LC, 1 revolving LC will be enough

And according to that $100,000 payment will be done every month

So, Revolving LC can stipulate that $100,000 can be drawn on monthly basis for 12 months

Next is, Sight LC

In Sight Lc,

When LC demands payment, when the documents are submitted, let's say

He ship the goods & submit the documents to the nominated bank

He will say that he has submitted the documents, then do my payment immediately because of this

The Nominated bank will verify the documents & will immediately do the payment

In this, the nominated bank does the payment within 7 days, which is good for the seller

Deferred Payment LC, in this

After the verification of documents, a particular time is set, also, the payment is not done immediately

Let's say, The payment will be done after 30 days of shipment date

Basically, this is good for buyer

Let's say, The buyer has got the goods after 25 days, then he can check and do the payment afterward

The buyer can claim if the seller has sent any defective item

So, Deferred Payment LC is good for Buyers

I think, I have covered all types of LC

If you want that I should cover any particular LC in detail then inform me

Like the video & send this to your Friends & Family

If you have any suggestions regarding this video or channel then comment in the comment box

Subscribe & Press the Bell Icon to get the notification of our latest finance videos

See you in the next video

Till then keep learning, keep earning, and stay happy