What Is an Irrevocable Letter of Credit?

An irrevocable letter of credit (LOC) is a financial instrument that guarantees payment from a buyer to a seller. In this type of letter of credit, the issuing bank guarantees the payment to the seller and the seller can be assured that they will receive the funds from the buyer. In this article, we will discuss the key features, benefits, and drawbacks of an irrevocable letter of credit.

What is an Irrevocable Letter of Credit?

An irrevocable letter of credit is a document issued by a bank on behalf of a buyer, which guarantees payment to a seller for goods or services provided. This type of letter of credit is called “irrevocable” because once it is issued, it cannot be changed or cancelled without the agreement of all parties involved.

How Does an Irrevocable Letter of Credit Work?

To use an irrevocable letter of credit, a buyer (importer) first requests one from their bank. The buyer’s bank then issues the letter of credit and sends it to the seller’s (exporter’s) bank. The seller’s bank confirms the letter of credit and notifies the seller that payment will be made upon completion of the transaction.

Once the seller has shipped the goods or completed the services, they must present the required documents to the bank within a specified time period. The bank will review the documents and, if they meet the requirements of the letter of credit, will release payment to the seller.

Benefits of an Irrevocable Letter of Credit

One of the primary benefits of an irrevocable letter of credit is that it provides a secure method of payment for both the buyer and the seller. The seller can be assured that they will receive payment upon completion of the transaction, and the buyer can be assured that the seller will only receive payment if they provide the goods or services as specified in the letter of credit.

Another benefit of an irrevocable letter of credit is that it can help to build trust between the buyer and the seller. By using this type of financial instrument, both parties can be assured that the other will fulfill their obligations under the contract.

Drawbacks of an Irrevocable Letter of Credit

One of the drawbacks of an irrevocable letter of credit is that it can be expensive for the buyer. The buyer must pay a fee to their bank to issue the letter of credit, and the seller may also charge a fee for the buyer to use this method of payment.

Another drawback of an irrevocable letter of credit is that it can be time-consuming. The process of issuing and confirming the letter of credit can take several days, which may delay the shipment of the goods or completion of the services.

Conclusion

An irrevocable letter of credit is a useful financial instrument for both buyers and sellers. It provides a secure method of payment and helps to build trust between the parties. However, it is important to be aware of the costs and time involved in using this type of letter of credit.

Frequently Asked Questions (FAQs)

Q: What are the types of irrevocable letters of credit?

Answer: There are two types of irrevocable letters of credit: confirmed and unconfirmed. A confirmed letter of credit involves an additional bank, usually a correspondent bank of the seller’s bank, that confirms the letter of credit and guarantees payment. An unconfirmed letter of credit involves only the issuing bank.

Q: Who pays for an irrevocable letter of credit?

Answer: The buyer pays for the irrevocable letter of credit. The buyer’s bank charges a fee to issue the letter of credit, and the seller may also charge a fee for the buyer to use this method of payment.

Q: What documents are required for an irrevocable letter of credit?

Answer: The specific documents required for an irrevocable letter of credit will depend on the terms of the letter of credit. Typically, the seller will be required to provide shipping documents, such as a bill of lading or airway bill, an invoice, and evidence that the goods or services have been delivered or completed.

Q: Can an irrevocable letter of credit be cancelled?

Answer: An irrevocable letter of credit cannot be cancelled without the agreement of all parties involved. If the buyer and seller agree to cancel the transaction, the issuing bank will cancel the letter of credit.

Q: What happens if the seller does not meet the terms of the irrevocable letter of credit?

Answer: If the seller does not meet the terms of the irrevocable letter of credit, the bank will not release payment to the seller. The buyer and seller will need to resolve any issues and agree on a course of action.

Q: How long does it take to process an irrevocable letter of credit?

Answer: The process of issuing and confirming an irrevocable letter of credit can take several days, depending on the complexity of the transaction and the banks involved. The buyer should allow enough time for the process to be completed before the shipment of the goods or completion of the services.

Q: Can an irrevocable letter of credit be amended?

Answer: An irrevocable letter of credit can be amended if all parties involved agree to the changes. The amendment must be in writing and signed by all parties. The issuing bank will then amend the letter of credit accordingly.

Q: Can an irrevocable letter of credit be transferred to a third party?

Answer: An irrevocable letter of credit can be transferred to a third party if the letter of credit allows for transfer. The transfer must be in writing and signed by the original beneficiary and the transferee. The issuing bank will then transfer the letter of credit to the new beneficiary.