Risk Management Manual of Examination Policies - FDIC

INTERNATIONAL BANKING Section 11.1
receives prepayment for the goods either through cash or
some other type of financing. If ABC is unable to prepay
in cash, it will request its bank to issue a letter of credit in
favor of the third company. If ABC’s bank agrees, the
domestic credit is then “backed” by the foreign letter of
credit and a back-to-back letter of credit transaction exists.
Letter of Credit - Cash – A letter addressed from one
bank to one or more correspondent banks making available
to the party named in the letter a fixed sum of money up to
a future specific date. The sum indicated in the letter is
equal to an amount deposited in the issuing bank by the
party before the letter is issued.
Letter of Credit - Commercial – A letter of credit
addressed by a bank, on behalf of a buyer of merchandise,
to a seller authorizing the seller to draw drafts up to a
stipulated amount under specified terms and undertaking
conditionally or unconditionally to provide payment for
drafts drawn.
• Confirmed Irrevocable Letter of Credit – A letter of
credit in which a bank in addition to the issuing bank
is responsible for payment.
• Irrevocable Letter of Credit – A letter of credit in
which the issuing bank waives all right to cancel or in
any way amend without consent of the beneficiary or
seller.
• Revocable Letter of Credit – A letter of credit in
which the issuing bank reserves the right to cancel or
amend that portion of the amount that has not been
demanded before the actual payment or negotiation of
drafts drawn.
• Revolving Letter of Credit – A letter of credit in
which the issuing bank notifies a seller of merchandise
that the amount of credit when used will again become
available, usually under the same terms and without
the issuance of another letter.
• Special Clauses –
o Green Clause – Similar to the red clause
letter of credit below, except that advance
payment is made, generally upon presentation
of warehouse receipts evidencing storage of
the goods.
o Red Clause – A clause permitting the
beneficiary to obtain payment in advance of
shipment so that the seller may procure the
goods to be shipped.
o Telegraphic Transfer Clause – A clause in
which the issuing bank agrees to pay the
invoice amount to the order of the negotiating
bank upon receipt of an authenticated
cablegram form the latter that the required
documents have been received and are being
forwarded.
Letter of Credit - Confirmed – A letter of credit issued
by the local bank of the imported and to which a bank,
usually in the country of the exporter, has added its
commitment to honor drafts and documents presented in
accordance with the terms of the credit. Thus, the
beneficiary has the unconditional assurance that, if the
issuing bank refuses to honor the draft against the credit,
the confirming bank will pay (or accept) it. In many
instances, the seller (exporter) may ask that the letter of
credit be confirmed by another bank when the seller is not
familiar with the foreign issuing bank or as a precaution
against unfavorable exchange regulations, foreign currency
shortages, political upheavals, or other situations.
Letter of Credit - Deferred Payment – A letter of credit
under which the seller’s draft specifies that the draft is
payable at a later date, for example, 90 days after the billof-lading
date or 90 days after presentation of the
documents.
Letter of Credit - Export – A letter of credit opened by a
bank, arising from the financing of exports from a country.
The issuing bank may request another bank to confirm or
advise the credit to the beneficiary. If confirmed, the credit
becomes a confirmed letter of credit, and, if advised, it
becomes an advised (unconfirmed) letter of credit.
Letter of Credit - Guarantee – A letter of credit
guaranteed by the customer (applicant) and often backed
by collateral security. In domestic banks, the payment of
drafts drawn under this credit is recorded in the general
ledger asset account “Customer Liability – Drafts Paid
under Guaranteed L/C.”
Letter of Credit - Import – A letter of credit issued by a
bank on behalf of a customer who is importing
merchandise into a country. Issuance of an import letter of
credit carries a definite commitment by the bank to honor
the beneficiary’s drawings under the credit.
Letter of Credit - Irrevocable – A letter of credit that
cannot be modified or revoked without the customer’s
consent or that cannot be modified or revoked without the
beneficiary’s consent.
Letter of Credit - Negotiation – A letter of credit
requiring negotiation (usually in the locality of the
beneficiary) on or before the expiration date. The
engagement clause to honor drafts is in favor of the
drawers, endorsers, or bona fide holders.
DSC Risk Management Manual of Examination Policies 11.1-41 International Banking (12-04)
Federal Deposit Insurance Corporation