What is an irrevocable credit?
An irrevocable credit is a form of documentary letter of credit in which the opening bank cannot unilaterally cancel or change the conditions without the consent of all parties: the issuer (buyer), the beneficiary (seller) and the intermediary bank. It is one of the safest forms of payment in international trade because the seller can be sure that once the conditions of the letter of credit have been met, such as the delivery of the relevant documents, the issuing bank will make the payment regardless of the buyer’s financial situation.
Frequently asked questions (FAQ)
1. How does a non-revocable credit work?
The process of a non-revocable credit starts with the buyer who applies to his bank to open a letter of credit in favor of the seller. The opening bank, i.e. the buyer’s bank, issues a letter of credit in which it undertakes to make payment after certain conditions have been met. The seller then delivers the goods and submits the required documents, such as the bill of lading, invoice or certificates, to their intermediary bank. This bank checks the documents and forwards them to the opening bank. After verification, the buyer’s bank makes the payment and the seller receives the funds due.
2. What types of irrevocable credit are there?
There are several types of irrevocable credit. Confirmed Irrevocable Credit means that in addition to the opening bank, the payment is also guaranteed by the intermediary bank, which increases the security of the transaction. In the case of Unconfirmed Irrevocable Credit, the payment obligation rests solely with the opening bank, without any additional guarantee. Transferable Credit allows the letter of credit to be transferred to another party, such as a sub-supplier, making it easier to fulfill large orders. Revolving Credit, on the other hand, is a revolving form in which the letter of credit is automatically renewed up to a certain amount after previous payments have been made.
3. What are the main advantages of an irrevocable letter of credit?
For the seller, an irrevocable credit ensures payment guarantee regardless of the buyer’s financial situation, which minimizes the risk of insolvency and delays. In addition, the possibility of securing a loan from a bank on the basis of a letter of credit increases the company’s financial liquidity. For the buyer, on the other hand, this form of payment builds greater credibility in the eyes of the supplier, which can lead to better commercial conditions, including more favorable prices.
4. What are the risks associated with irrevocable credit?
Despite its many advantages, an irrevocable credit also involves certain challenges. First of all, it requires precise preparation of documents that must comply with the terms of the letter of credit, which can generate additional formalities. Opening and maintaining a letter of credit also involves bank charges, which can be significant. Another limitation is the lack of flexibility – once the conditions have been set, they cannot be changed without the consent of all parties, which can be a hindrance in dynamic commercial transactions.
5. In which industries is the irrevocable credit used?
Irrevocable credit is commonly used in international trade, where it secures export and import transactions. It is especially popular in heavy industry, where it is used to finance the supply of machinery, equipment and large infrastructure investments. It is also used in the trade of raw materials and bulk commodities such as oil, gas, steel, wood and grain.
Irrevocable Credit is a safe and secure form of payment in international transactions, guaranteeing that the seller will receive the funds provided that the documentary conditions are met. Although it involves additional costs and formalities, it ensures stability and minimizes the risk of counterparty insolvency.
