Back-to-Back Letters of Credit
What Are Back-to-Back Letters of Credit?
Back-to-back letters of credit comprise of two letters of credit (LoCs) utilized together to finance a transaction. A back-to-back letter of credit is normally utilized in a transaction including an intermediary between the buyer and seller, like a broker, or when a seller must purchase the goods it will sell from a provider as part of the sale to his buyer.
Figuring out Back-to-Back Letters of Credit
Back-to-back letters of credit are really comprised of two distinct LoCs, one issued by the buyer's bank to the intermediary and the other issued by the intermediary's bank to the seller. With the original LC from the buyer's bank in place, the broker goes to his own bank and has a second LC issued, with the seller as the beneficiary.
The seller is accordingly guaranteed of payment after satisfying the terms of the contract and introducing the proper documentation to the intermediary's bank. Now and again, the seller may not even know who the ultimate buyer of the goods is.
As is much of the time the case with LCs, back-to-back LCs are utilized basically in international transactions, with the main LC filling in as collateral for the second.
Back-to-back LCs basically substitute the two giving banks' credit to the buyer's and intermediary's and in this manner assist with working with trade between parties who might be dealing from great distances and who may not in any case have the option to confirm each other's credit.
Illustration of a Back-to-Back Letter of Credit Transaction
For instance, expect that Company An is in the U.S. furthermore, sells heavy machinery. Broker B, a trading firm situated in London, has discovered that Company C, which is situated in China, needs to purchase heavy machinery and has managed to broker a deal between the two companies. Company An is anxious to sell yet doesn't have any desire to face the risk challenges default of payment by Company C. Broker B needs to guarantee that the trade is made and that it accepts its commission.
Back to back LCs can be utilized to ensure the transaction goes through. Company C will go to a notable financial institution in China and inspire it to issue a LC with Broker B as beneficiary. Thusly, Broker B will utilize that LC to go to its own notable financial institution in Germany and have it issue a LC to Company A.
Company A can now ship its heavy machinery realizing that once the transaction is complete, it will be paid by the German bank. The broker is additionally guaranteed of being paid. The credit risk has been eliminated from the transaction.
- Back-to-back letters of credit are utilized essentially in international transactions.
- A back-to-back letter of credit includes two letters of credit to secure financing for a single transaction.
- These are generally utilized in a transactions including an intermediary between the buyer and seller.