Difference Between Revocable And Irrevocable Letter Of Credit
Mar 18, 2021 - 07:01 PMAuthor - Kenneth
What Is A Letter Of Credit?
A letter of credit is a legal financial document that is issued by a bank or private financial institution on behalf of its client i.e. buyer to provide security to the seller of goods & services as long as the conditions of the LC contract are fulfilled. In short, by issuing an LC, the issuing bank takes a guarantee of on-time payment to the seller in the event if the buyer defaults in paying or fulfilling the terms & conditions of the contract. Along with the seller, the buyer also gets the security that he will receive the goods or services in the manner they have been ordered.
A letter of credit can be revocable or irrevocable but what is the difference between them? Let’s find out:
Revocable Letter of Credit
- A revocable LC can be modified, amended, or canceled by the issuing bank after its issuance without taking the persimmon or giving any prior notice to the beneficiary.
- This type of legal arrangement demonstrates a few things that either the issuing bank does not want to bear the risks of guaranteeing the underlying payment between the buyer and the seller, or the issuing bank does not have the financial strength to guarantee the payment of the underlying payment.
- There is one exception regarding the terms of revocating the credit. The issuing bank is required to reimburse the nominated or confirming bank with which the revocable letter of credit has been issued only if the fulfillment of the obligations takes place by these banks under the documentary credit terms & conditions against complying presentation before receiving the notice of amendment or cancellation from the issuing bank.
- It is a limited security payment method for the beneficiaries as they are subject to amendment or cancellation without prior consent.
- As a result, these revocable letters of credit are not frequently used in international trade.
- As there is not an absolute undertaking by the issuing bank in the revocable letter of credit, the exporters are not under that much benefit.
- The bank in the exporter’s country is not aware of any cancellation or amendment, therefore bears the risks of payment being refused by the issuing bank.
When To Use Revocable LC?
Since revocable LCs are exposed to any type of amendment, modification, or cancellation, these are less-often used by importers & exporters across the world. Instead of revocable LCs, global traders should always seek irrevocable LCs.
Irrevocable Letter of Credit
- An irrevocable Letter of credit is a type of letter of credit which does not allow its issuing bank to modify, amend or cancel without seeking prior consent or giving an acknowledgment of the same to the beneficiary.
- In simple words, the issuing bank does not have the power to modify the terms & conditions of the irrevocable LC until it gets authorization from the beneficiary. Any type of amendment requires the beneficiary's acceptance to be effective.
- An irrevocable letter of credit provides much more security to the beneficiary in comparison to revocable ones due to the transparency of the modifications.
- As a result, these letters of credit are widely used by global traders while executing an international transaction.
- The confirming bank is not compelled to add its confirmation to any type of amendment. Additionally, the transferable LCs should not be issued as revocable letters of credit.
- The exporter feels more secure with the knowledge that the bills drawn under the credit will be honored by the issuing bank after the fulfillment of conditions of the LC agreement.
- Any amendment or cancellation of credit will not be effective unless the exporter gives consent to such amendment or cancellation.
When To Use An Irrevocable LC?
To facilitate a higher degree of security in international transactions, both the importers and exporters always prefer an irrevocable letter of credit over revocable. This especially occurs when the relationship between the buyer and the seller or between the bank and the applicant is relatively new.
These were some of the points of difference between revocable & irrevocable LCs where the preference of choice depends on ensuring safe & secure international trade transactions.
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