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| Corporate Practice bd |
A back-to-back letter of credit (LC) is a financial instrument used in international trade where two separate LCs are issued for the same shipment of goods. In this arrangement, the seller (the exporter) receives a LC from the buyer's bank (the issuing bank) and uses it as collateral to obtain another LC to pay the actual supplier of the goods.
Here's how it works:
Original LC:
The buyer (importer) establishes a LC in favor of the seller (exporter). This LC guarantees payment to the exporter upon presenting compliant shipping documents.
Back-to-Back LC:
The exporter, instead of relying on the original LC for payment, uses it as collateral to obtain a second LC from their bank (the advising bank). This second LC is in favor of the supplier (often a manufacturer or another supplier) who provides the goods.
Key differences between a master LC and a back-to-back LC:
Number of LCs:
In a master LC, there is only one LC involved, typically issued by the buyer's bank to the seller. In contrast, a back-to-back LC involves two LCs: one from the buyer's bank to the seller and another from the seller's bank to the supplier.
Purpose:
A master LC is used when the seller needs assurance of payment before shipping the goods, while a back-to-back LC is utilized when the seller doesn't have direct access to the goods and needs to purchase them from a third party.
Payment Flow:
In a master LC, payment flows directly from the buyer's bank to the seller. In a back-to-back LC, the payment flows from the buyer's bank to the seller's bank, which then pays the supplier.
Risk Management:
A master LC might involve less risk for the buyer, as they deal directly with the seller. In a back-to-back LC, there might be more complexity and potential risk due to involving multiple parties and transactions.
Both types of LCs serve to facilitate international trade by providing security and assurance of payment to the parties involved.