There are really only two basic forms of letters of credit in the trade finance market: the standby letter of credit (SBLC) and the documentary letter of credit (DLC).
Revocable or Irrevocable Documentary Letters of Credit
Documentary letters of credit (DLC) can be issued either revocable or irrevocable. Most documentary letters of credit are issued as irrevocable DLCs, as revocable DLCs are very rare.
Revocable Documentary Letters of Credit
Revocable Documentary Letters of Credit can be modified or even cancelled by the buyer without notifying the seller.
For this reason, they are not acceptable to the seller in most cases.
Irrevocable Documentary Credits
Irrevocable documentary letters of credit are the most common type of letter of credit used in global trade and cannot be modified or canceled by the buyer.
As long as the seller complies with the terms of the letter of credit, the buyer’s issuing bank must make payment to the seller when it is made.
Any amendment to the irrevocable documentary letter of credit must be approved by both parties to the transaction.
Unless specified as revocable, a documentary letter of credit is automatically deemed irrevocable.
Confirmed or Unconfirmed Documentary Letters of Credit.
Irrevocable documentary letters of credit are issued as confirmed or unconfirmed. Both types of letters of credit have their own advantages and disadvantages for the buyer and the seller.
The costs are also different for the two types. Generally, the more risk a bank takes with the payment guarantee, the higher the cost of issuing the letter of credit.
Unconfirmed Documentary Letters of Credit
This type of letter of credit is an irrevocable letter of credit that is not confirmed by an advising bank.
In an unconfirmed documentary letter of credit, the buyer’s issuing bank is the only party that guarantees payment to the seller.
Payment to the seller is made by the advising bank only after it has received payment from the issuing bank. The advising bank is merely an intermediary between the issuing bank and the seller.
Confirmed Documentary Letters of Credit
This type of letter of credit is an irrevocable letter of credit confirmed by an advising bank.
Both the advising bank and the issuing bank guarantee payment to the seller when requested.
The advising bank first verifies and confirms that all documentary requirements of the letter of credit have been met and pays the seller.
The advising bank then contacts the issuing bank directly to obtain payment.
Confirmed irrevocable documentary letters of credit are often used when trade takes place in an area where political, social or unstable conditions prevail.
They are also used when the seller does not know the bank or financial institution issuing the letter of credit, or when a seller must obtain bank financing using a confirmed documentary letter of credit.
A confirmed documentary letter of credit is usually issued for a higher fee because the bank assumes greater liability.