Table Of Contents
What Is Irrevocable Letter Of Credit?
An irrevocable Letter of Credit is a payment guarantee issued by the importer's bank that cannot be revoked, altered, or modified without the approval of all parties involved. It ensures secure exchange of goods between exporter and importer.
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Moreover, it is a secure payment method for international trade. It is used to reduce payment risk and build confidence between sellers and buyers. Sellers rely on this document to guarantee payment. On the other hand, purchasers benefit from the confidence that cash will be paid if products or services are provided as promised.
Process Steps
The process of acquiring an irrevocable letter of credit involves several steps, which are as follows
- Buyer and seller agree on transaction terms.
- Buyer requests an irrevocable LC from their bank.
- The buyer's bank issues the irrevocable letter of credit to the seller.
- The issuing bank sends the letter to the advising bank, which notifies the beneficiary.
- Seller receives the irrevocable letter of credit from their bank.
- Seller ships goods or provides agreed-upon services.
- The seller presents the required or necessitated documents to their bank.
- The seller's bank verifies and forwards documents to the buyer's bank.
- The buyer's bank reviews documents and makes payments to the seller's bank.
- The seller's bank credits payment to the seller's account.
Note: If beneficiaries doubt the issuing bank's ability, they can request confirmation from their bank or a reputable international institution. Similarly, payment terms can be immediate (at sight) or deferred to a fixed future time.
Advantages And Disadvantages
Some of the advantages of ILOC are given as follows:
#1 - Assurances In Global Trade
An ILOC acts as an unwavering commitment from the buyer's bank to compensate the seller upon receipt of compliant documents. This effectively reduces international trade payment risks, fostering security and expanding global trade opportunities. Additionally, options such as discounting of accepted drafts and pre-shipment finance improve transaction viability. Furthermore, LCs' independence from sales contracts ensures payment guarantees even amidst disputes, offering added security.
#2 - Strengthening Trust among Trade Partners
Irrevocable LCs cultivate confidence and assurance vital for international transactions, supported by the expertise of issuing banks in risk mitigation. LCs ensure payment upon meeting terms, bolstering enduring trade relationships and nurturing trust between involved parties. The assurance of payment security fosters trust, streamlining trade operations effectively.
#3 - Advantages For The Seller
For sellers, a confirmed irrevocable letter of credit provides a secure payment mechanism, safeguarding them against buyer default risks. Financial opportunities like pre-shipment finance aid in managing cash flow, and the flexibility to remit payments to the seller's preferred bank adds convenience. Overall, LCs offer sellers peace of mind and financial stability in trade dealings.
#4 - Benefits For The Buyer
Buyers benefit from ILOC through timely delivery and shipment of goods as laid out in contract terms. This payment method facilitates effective cash resource management, preventing untimely expenses and granting negotiation leverage for favorable trade terms. With protection against non-compliance, buyers gain confidence in trade transactions, ensuring their interests are safeguarded.
Some of the disadvantages of ILOC are listed below:
#1 - Buyer's Financial Obligations
Utilizing this document burdens the buyer with various fees, including advising fees, bank fees, negotiation fees, and confirmation fees. These expenses can significantly inflate the overall transaction costs, placing a financial strain on the buyer.
#2 - Unforeseen Expenditures
Unexpected costs may arise due to factors such as delivery delays, document discrepancies, or fluctuations in exchange rates. If not anticipated and adequately planned for from the outset, these unforeseen expenses can impose a significant financial burden.
#3 - Necessity For Thorough Assessment
Parties engaged in international trade must meticulously evaluate all associated fees and potential hidden costs before committing to an irrevocable credit letter. Failing to conduct a comprehensive assessment beforehand may lead to unforeseen financial complexities and challenges throughout the transaction process.
Irrevocable Letter Of Credit Vs. Standby Letter Of Credit Vs. Revocable Letter Of Credit
The differences between the concepts are given below:
| Points | Irrevocable Letter Of Credit | Standby Letter Of Credit | Revocable Letter Of Credit |
| Definition | This document remains unalterable or cancellable without unanimous agreement from all involved parties.
| A standby letter of credit is an LC that acts as a guarantee for payment should the buyer default on their obligations.
| A revocable letter of credit i permits modifications or cancelations by the issuing bank without requiring consent from the beneficiary.
|
| Payment Assurance | It provides payment assurance to the seller, ensuring transaction security.
| The standby agreement implies that the bank will intervene only if the buyer defaults on payment.
| A revocable letter of credit offers payment assurance but allows for potential cancellation by the issuing bank.
|
| Cancellation | It cannot be canceled unless all parties agree. | The standby letter of credit can be canceled by the issuer within the agreed notice period without the beneficiary's consent.
| It can be canceled. |
Frequently Asked Questions (FAQs)
How much does an irrevocable letter of credit cost?
How do I get an irrevocable letter of credit?
What does it mean to have an irrevocable letter of credit at sight?
Is an irrevocable letter of credit transferable?
What Is Irrevocable Letter Of Credit?
Key Takeaways
- Accounting fraud or bookkeeping fraud is a deception in which an individual or a group of individuals portrays a company's financial situation in a false manner.
- It can be done through inflating revenue, deflating expenses, understating assets, or overstating liabilities.
- Regulation and enforcement bodies such as the SEC, IRS, and FBI catch such frauds. Employees and executives can be awarded hefty fines, prison, time, and probation.
- As a result of these fraudulent activities, the company ironically incurs significant economic burdens in terms of legal fees and other expenses. Investors lose confidence in the company, which has a significant economic impact.
Irrevocable Letter Of Credit Explained
An Irrevocable Letter of Credit (ILOC) is an official correspondence from a bank guaranteeing payment for goods purchased by an importer. The issuing bank requests the ILOC. It cannot be canceled or altered without the full consent of all parties involved, including the exporters, importers, and issuing banks.
The issuing bank is bound by its contractual obligations and is not authorized to amend the terms of an ILOC once it has been issued. ILOCs are often used for large transactions, which promote international trade due to the added credit risk. They also help exporters obtain payment by ensuring payment from the issuing bank. This means that if a buyer cannot make a payment, the bank is responsible for covering the outstanding amount. This could be partial or full, depending on the circumstances.
It shall be noted that the buyer is only required to pay once the cargo is sent, and the seller receives payment if the letter's terms are followed. The LC is issued on the buyer's behalf and includes specified documents to authenticate the provision of goods or services. When the cargo is shipped, the buyer's or issuing bank transmits the shipment information to the seller's bank for approval and payment. In the event of delays or document problems, the bank has the right to withhold payment.
The letter specifies provisions for loan terms and conditions, including disbursement authority, document acknowledgment security, custody of commodities, boycott, and blacklisting. It also defines stakeholders' responsibilities in the event of misconduct, omission, fraud, or insolvency. Additionally, the letter provides procedures for timely payments, settlements, renewals, and exceptional circumstances requiring stakeholder approval.
Process Steps
Examples
Let us look into a few examples to understand the concept better.
Example #1
Suppose Company A, a US company, plans to buy goods from Company B, a UK company, and establish a secure payment arrangement by opening an irrevocable letter of credit with their bank. This guarantees payment upon fulfilling the agreed terms and conditions. Company B fulfills its part of the transaction by delivering goods and presenting necessary documents for verification.
Company B's bank examines these documents to ensure compliance with the letter of credit terms. Then, it forwards them to Company A's bank in Country X. If everything is in order, Company A's bank makes the payment to Company B's bank, and finally, Company B's bank credits the payment amount to Company B's account, ensuring a smooth international trade transaction.
Example #2
The provided information is based on an irrevocable letter of credit sample issued by a bank to the Commissioner of Agriculture and Markets, State of New York, on behalf of an applicant.
The letter specifies the maximum amount available for drawing, the effective date, and the expiration date. It covers payments due to cooperative associations, producers, and individual producer-members under milk marketing orders. Drafts drawn under this letter must accompany a certificate from the Commissioner of Agriculture and Markets. The letter outlines conditions for expiration and renewal, as well as requirements for honoring drafts and presenting documents. An authorized representative of the issuing bank signs the letter.
