Let us talk about the different kinds of most frequently used letters of credit or LCs.
We say that a LC is Unconfirmed when the documents that back it up only show the bank guarantee issued by the importer’s bank. The role of the notifying bank is to let the exporter know what the LC establishes but without paying for the merchandise. It is the responsibility of the exporter to obtain payment for the merchandise from a bank usually located in the country of the importer.
There are also back to back LCs. In short, they are two LCs that together form a transferable LC. These kinds of letters allow exporters who are not subject to credit to sell their products aboard.
When a LC is issued in favor of an exporter in a foreign country, some financial institutions will also issue LC to the suppliers of that exporter so that he or she is able to buy the merchandise it needs for the products. When one LC has been approved, the second one is valid in spite of the first one being not well written. The issuing bank is expected to pay for the products according to what the LC says.
Financial institutions generally shy away from using back to back LC because they have inconveniences for them. For one, there are more transactions involved, which increase the level of complexity and the potential for errors and dispute.
In order for banks to protect themselves against any problem with back to back LC, they are more demanding of information to the exporter. Exporters then need to show documentation that proves that the shipment arrive according to the conditions established in the LC. The expiration dates of the two LCs also have to coincide, being the second one before the first one. Naturally, the first LC will allow the exporter enough time to provide the necessary documents.
A standby LC: Unlike the regular LC which is basically a payment mechanism, a standby LC is a kind of bank guarantee that is used to cover financial obligations for non-payment. The bank issues a standby LC that held by the seller provides the customer open account terms. If payment is carried out in accordance with the conditions set by the seller, the LC is not used. However, if the client cannot make payment, the seller presents a bill of exchange with copies of invoices to the bank along with other necessary documents. The standby LC generally expires after twelve months.
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