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| Corporate Practice bd |
What are Red-clause and Green-clause-letter-of-credit
Letters of credit are essential financial instruments in international trade, offering security to both buyers and sellers. Red-Clause and Green-Clause Letters of Credit are specialized types that provide for advance payments to the beneficiary.
Red-Clause Letter of Credit
Definition: A Red-Clause Letter of Credit allows the beneficiary (usually the seller or exporter) to receive an advance on the credit before shipping the goods. This clause is typically printed in red ink to highlight its importance, hence the name "Red-Clause."
Key Features:
Advance Payment:
The issuing bank or an intermediary bank provides an advance payment to the beneficiary before the shipment of goods.
Purpose:
The advance is usually intended to cover the purchase of raw materials, production costs, or other expenses necessary to fulfill the contract.
Documentation:
The beneficiary must provide a written undertaking to use the funds solely for the preparation and shipment of the goods. Often, the beneficiary also provides a receipt and a statement of utilization of the advance.
Repayment:
The advance amount is deducted from the final payment under the Letter of Credit upon presentation of the shipping documents.
Advantages:
For Beneficiary:
Provides working capital to produce or procure goods.
For Buyer:
Ensures that the seller has the necessary funds to complete the transaction.
Disadvantages:
Risk for Issuing Bank:
The bank bears the risk if the beneficiary fails to ship the goods after receiving the advance.
Example:
A textile exporter receives a Red-Clause Letter of Credit that allows an advance of $50,000 to purchase raw materials. The exporter uses the advance to procure cotton, produce garments, and then ships the finished goods to the buyer. Upon shipment, the exporter presents the shipping documents, and the advance is deducted from the final payment.
Green-Clause Letter of Credit:
Definition:
A Green-Clause Letter of Credit is similar to a Red-Clause Letter of Credit but provides additional security by requiring the beneficiary to provide warehousing receipts or other collateral in exchange for the advance payment. The clause is often printed in green ink.
Key Features:
Advance Payment with Security: The issuing bank provides an advance payment against the presentation of warehouse receipts or other forms of collateral.
Additional Documentation:
Besides the standard documentation, the beneficiary must present warehousing receipts or other proof that the goods are stored and available for shipment.
Repayment:
The advance is deducted from the final payment upon presentation of the shipping documents, similar to the Red-Clause Letter of Credit.
Advantages:
For Beneficiary:
Provides working capital with the added security of collateral.
For Issuing Bank:
Reduced risk due to the collateral provided by the beneficiary.
Disadvantages:
Additional Documentation:
Requires more paperwork and the establishment of collateral.
Example:
A grain exporter receives a Green-Clause Letter of Credit that allows an advance of $100,000 against warehousing receipts. The exporter uses the advance to purchase grain and stores it in a warehouse. The warehouse receipts are then provided to the bank as collateral. Upon shipment, the exporter presents the shipping documents, and the advance is deducted from the final payment.
|
Advantage for Beneficiary |
Provides necessary working capital |
Provides necessary working capital with added security |
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Advantage for Issuing Bank |
None (riskier) |
Lower risk due to collateral |
Conclusion:
Both Red-Clause and Green-Clause Letters of Credit provide critical financial support to beneficiaries by offering advance payments. The choice between them depends on the level of risk the issuing bank is willing to accept and the ability of the beneficiary to provide collateral. Understanding these instruments is essential for businesses engaged in international trade to manage their working capital efficiently and reduce financial risks.