Revolving letter of credit
The revolving letter of credit is a special type of letter of credit, which is constructed in a way so that it revolves either:
- in time embracing multiple-shipments over a long period of time according to a single letter of credit,
- in value.
The main goal of the revolving letter of credit is to meet the needs of firms in various countries whose business transactions are[1]:
- regular with one another more or less and
- continuous, at the least over a certain period of time.
The letter of credit
The letter of credit can be arranged to cover payment for numbers of shipments which will cover the complete contracted price for the merchandise. In the beginning, the letter of credit will be supplied to cover payment for the first shipment. Later, as soon as the beneficiary is paid for that special shipment and the goods are shipped, the amount drawn under the letter of credit for the next shipment is reinstated. Afterward, it looks the same until the whole aggregate of goods covered through the letter of credit has been paid of the drawings and has been shipped[2].
Types of the letter of credit
There are some types of letter of credit[3]:
- The irrevocable letter of credit,
- Documentary letter of credit,
- Clean letter of credit,
- The revocable letter of credit.
The irrevocable letter of credit
The irrevocable letter of credit is one which may not be modified or canceled without the agreement of the beneficiary. The irrevocable credit is definite as undertaking on the part of the issuing bank. Moreover, the irrevocable letter of credit constitutes:
- every bonafide holder of the drafts drawn under the credit or
- the engagement of that bank to the beneficiary,
presuming that the terms and conditions of the credit have complied.
Documentary letter of credit
Secured or a documentary letter of credit is that one which the supplying bank undertakes to honor the bills drawn according to it to merely when it receives with it certain documents such as:
- certificate of origin,
- insurance policy invoice,
- bill of lading, etc.
That documents are held through the issuing bank as security for the advance executed by it.
Clean letter of credit
An open or a clean letter of credit is that one where no documents are engaged. The issuing bank commits to honor the bills beyond the production of any documents. That the letter of credit is expended for customers of high financial standing.
The revocable letter of credit
The revocable letter of credit can be canceled or revoked at any time without:
- notice to the beneficiary and
- without the consent of.
While the revocable letter of credit does not sufficiently protect the beneficiary so the exports are not common on the basis of that type of letter of credit.
Examples of Revolving letter of credit
- A revolving letter of credit is an agreement between a buyer and a seller in which the buyer agrees to provide a certain amount of money to the seller on an ongoing basis, in exchange for goods or services. The buyer and seller agree to a certain limit for the revolving letter of credit, and the buyer can draw on the credit whenever they need to make a purchase from the seller. This type of letter of credit is often used in business-to-business transactions.
- A revolving letter of credit can also be used to finance an ongoing project. In this case, the buyer agrees to provide a certain amount of money upfront, with the limit determined by the estimated cost of the project. The buyer can then draw on the credit as needed to finance the project, up to the limit.
- A revolving letter of credit can also be used to finance an international transaction. In this case, the buyer agrees to provide a certain amount of money upfront, with the limit determined by the estimated cost of the transaction. The buyer is then able to draw on the credit as needed to finance the transaction, up to the limit. This type of letter of credit is especially useful for transactions that require multiple payments over a period of time.
Advantages of Revolving letter of credit
A revolving letter of credit is a special type of letter of credit, which is constructed in a way so that it revolves either through a single facility or a series of transactions. The main advantages of using a revolving letter of credit are:
- It provides an efficient way to finance the working capital needs of the borrower, while still providing the security of the letter of credit.
- It can be tailored to meet the specific needs of the borrower, including a variety of payment terms, maturity dates and interest rates.
- It allows for a streamlined process for the borrower to access funds, as the amount of the credit can be adjusted to meet the borrower's changing needs.
- It also allows the lender to manage their risk exposure more effectively, by allowing them to adjust the amount of the credit limit to reflect the borrower's current financial situation.
- Finally, it allows for a more flexible way to secure payment, as the borrower can make payments on the credit line as needed, rather than having to make a large payment in one lump sum.
Limitations of Revolving letter of credit
The revolving letter of credit is a special type of letter of credit, which is constructed in a way so that it revolves either predetermined amount or for a period of time. Despite its advantages, this type of letter of credit also has certain limitations that must be considered:
- The bank issuing the revolving letter of credit must be willing and able to commit to the same terms for the duration of the agreement.
- The beneficiary of the letter of credit must be able to provide the goods or services within the specified time frame.
- The amount of the letter of credit must be sufficient to cover the costs of the goods or services provided.
- The issuing bank must be able to track the amount of funds used and available in the letter of credit at all times.
- The parties involved must have a clear understanding of the terms of the letter of credit, including any fees or charges associated with its use.
- The issuing bank must be able to monitor the creditworthiness of the customer in order to ensure that they are able to meet their obligations.
- The terms of the letter of credit must be clearly stated and agreed upon by all parties involved.
- The letter of credit must be able to be renewed or canceled at the request of either party.
A revolving letter of credit is a special type of letter of credit that is set up to revolve either periodically or throughout the term of the agreement. There are various other approaches related to revolving letter of credit that can be adopted, such as:
- Standby Letter of Credit: This is a form of payment guarantee which is issued to provide assurance that the issuer will honour a demand for payment if the beneficiary makes a claim.
- Documentary Letter of Credit: This is a type of letter of credit which requires the beneficiary to present relevant documents in order to receive payment from the issuing bank.
- Transferable Letter of Credit: This is a type of letter of credit which can be transferred to a third party.
- Back-to-Back Letter of Credit: This is a type of letter of credit which is used to finance exports and imports, and is based on two separate letters of credit.
In summary, revolving letters of credit are a special type of letter of credit with various other approaches related to them, such as standby letters of credit, documentary letters of credit, transferable letters of credit, and back-to-back letters of credit.
Footnotes
| Revolving letter of credit — recommended articles |
| Transferable letter of credit — Back-To-Back Letters Of Credit — Counter guarantee — Shipping guarantee — Delivery Notice — Counterpurchase — Advance payment — Offtake Agreement — Staged payments |
References
- Hinkelman E.G., (2005)., Dictinoary of International Trade: Handbook of the Global Trade Community Includes 21 Key Appendices, World Trade Press
- Periasamy M., (2009)., Financial Management,Tata McGraw-Hill Education
- Sumangil C.A., (2014)., Keys to Understanding Documentary Letters of Credit, Lulu Press
Author: Mateusz Gołda
