Demystifying Revocable & Irrevocable LCs


 

Here's a simple explanation of Revocable and Irrevocable LCs, using a restaurant reservation analogy:

Imagine a Letter of Credit (LC) is like a restaurant reservation:

  • The buyer (like a hungry customer): Makes a reservation (opens the LC) to ensure a table is available.
  • The restaurant (like the issuing bank): Promises to hold a table for the customer.

Revocable LC:

  • Like a reservation the restaurant can cancel: The restaurant might change their mind and give the table to someone else if a bigger group comes in or they need the space for something else.
  • It's not a very reliable promise.

Irrevocable LC:

  • Like a reservation that's guaranteed: The restaurant is legally obligated to hold the table for the customer, no matter what.
  • It's a strong commitment that can't be easily broken.

In trade terms:

  • Revocable LC: The issuing bank can amend or cancel the LC without the beneficiary's consent, making it less secure for the seller.
  • Irrevocable LC: The issuing bank cannot change or cancel the LC without the agreement of both the buyer and seller, providing stronger protection for the seller.

Benefits of Irrevocable LC:

  • Increased security for the seller: Assurance of payment as long as they fulfill their contractual obligations.
  • Reduced risk of non-payment: The buyer cannot back out of the deal without significant consequences.
  • Enhanced trust and confidence: Promotes smoother transactions and stronger trading relationships.

When to use Irrevocable LC:

  • Most international trade transactions use irrevocable LCs as standard practice.
  • It's essential for transactions involving significant financial risks or where trust between parties is limited.

Remember:

  • Revocable LCs are rarely used due to their inherent risks for the seller.
  • Irrevocable LCs are the preferred choice for most international trade scenarios.

Please reach out to me for your Trade Finance needs.

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