Financial SBLC
Supports defined payment, repayment or other financial obligations.
Types of Letters of Credit: Documentary, Sight & Standby LC
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Trade Finance | Documentary Credits | SBLC | Letters of Credit
Types of Letters of Credit and How They Differ
Letters of credit are among the most established payment and risk-management instruments in international trade. A buyer can instruct its bank to issue a documentary credit in favor of a seller, giving the seller a bank undertaking to pay when the required documents are presented in compliance with the credit.
The International Chamber of Commerce describes a documentary credit as an irrevocable bank undertaking to honor a complying presentation. UCP 600 provides the principal international rules used for documentary credits when the instrument expressly incorporates them.
The terminology can become confusing because letters of credit can be classified in several different ways. A credit can be confirmed and payable at sight. It can also be transferable and confirmed. Another credit might be irrevocable, deferred-payment and revolving.
These descriptions address different characteristics of the same instrument.
Structure the Right Letter of Credit
Financely helps companies evaluate documentary credits, standby letters of credit and structured trade finance facilities around the underlying commercial transaction.
Request a Trade Finance ProposalHow to Understand Different Types of Letters of Credit
Understanding the differences starts by separating four questions.
1. What Commercial Purpose Does the LC Serve?
Determine whether the instrument is intended to make payment under a trade transaction or provide security against default or non-performance.
2. When Does the Beneficiary Receive Payment?
The credit may provide for sight payment, deferred payment, acceptance or negotiation.
3. Which Banks Have Undertaken to Pay?
An issuing bank provides the core undertaking while a confirming bank can add its own separate undertaking.
4. Can the Credit Be Transferred or Reused?
Certain structures can accommodate intermediaries, recurring transactions or supplier financing.
Once those questions are separated, the various types of letters of credit become considerably easier to understand.
Documentary Letter of Credit
The conventional documentary letter of credit is primarily a payment instrument used in trade. The buyer, known as the applicant, asks its bank to issue a credit in favor of the seller, known as the beneficiary.
The issuing bank undertakes to honor a complying presentation of documents according to the terms of the credit.
Required documents might include:
- Commercial invoice
- Bill of lading
- Packing list
- Certificate of origin
- Inspection certificate
The exact requirements depend on the commercial transaction and wording of the credit.
Banks deal with documents rather than physically inspecting the goods. The documentary credit also operates independently from the underlying sale contract.
A conventional documentary credit is particularly useful where a seller wants bank-supported payment security while the buyer wants payment to depend on specified documentary evidence of performance.
Standby Letter of Credit
A standby letter of credit serves a different commercial purpose.
A conventional documentary credit is generally expected to function as the normal payment mechanism. A standby typically provides secondary protection against a default or failure to perform.
The beneficiary expects the underlying obligation to be satisfied normally and draws under the standby when the event described by the instrument occurs.
A company might be required to provide an SBLC supporting a loan repayment obligation. A contractor could provide a performance standby. Another applicant may need an advance-payment standby or bid-related undertaking.
Common standby categories include:
- Financial standbys
- Performance standbys
- Advance-payment standbys
- Bid or tender standbys
- Counter-standbys
- Commercial standbys
Standbys can be made subject to UCP 600, although ISP98 was developed specifically for standby practice.
| Instrument | Primary Commercial Function |
|---|---|
| Documentary LC | Payment against complying trade documents |
| Standby LC | Security against default or non-performance |
Irrevocable Letter of Credit
Modern documentary credits subject to UCP 600 are irrevocable.
The undertaking cannot generally be amended or cancelled without the required agreement of the issuing bank, beneficiary and confirming bank where one has added its confirmation.
ICC guidance confirms that a credit is irrevocable even where the word "irrevocable" does not appear in the instrument.
Irrevocability gives the beneficiary substantially greater certainty. A seller can manufacture or ship goods with greater confidence that the bank undertaking will remain available subject to compliance with the credit terms.
Revocable Letter of Credit
Revocable credits occasionally appear in discussions about LC types, although they have little relevance to modern UCP 600 practice.
ICC guidance states that the concept of revocability was removed from UCP 600. A transaction seeking to establish a revocable arrangement would have to create that feature specifically through its own terms.
From the seller's perspective, revocability substantially reduces payment certainty.
For most commercial discussions today, a documentary credit should therefore be understood as an irrevocable undertaking unless the transaction establishes something unusual.
Sight Letter of Credit
A sight LC deals with when payment becomes due.
Under a documentary credit available by sight payment, the beneficiary receives payment after making a complying presentation and the bank completes the required documentary examination.
UCP 600 requires a credit to specify whether it is available by sight payment, deferred payment, acceptance or negotiation.
Example of a Sight LC
Consider an exporter selling $2 million of copper cathodes. The LC requires a commercial invoice, bill of lading, certificate of origin and inspection certificate. Once the exporter makes a complying presentation under the sight credit, the relevant bank's payment obligation follows the terms of the credit.
The buyer may separately have a reimbursement arrangement with the issuing bank. That does not change the documentary undertaking owed to the beneficiary.
Deferred Payment Letter of Credit
A deferred-payment LC introduces a future payment date.
The beneficiary presents the required documents and establishes a complying presentation. Payment then becomes due at the future date specified by the credit rather than immediately after document examination.
For example, the credit might provide for payment 90 days after the bill-of-lading date.
This gives the buyer supplier-like credit while the seller benefits from a bank undertaking.
Deferred-payment structures are particularly relevant where commercial terms require time between shipment and final cash settlement.
The beneficiary may also be able to obtain financing against the bank's deferred-payment undertaking.
Acceptance Letter of Credit
An acceptance credit also creates payment at a future date, although the traditional structure involves a time draft or bill of exchange.
The relevant bank accepts the draft and undertakes to pay it at maturity when the documentary requirements have been satisfied.
Acceptance credits therefore belong to the broader category of usance or term credits.
Modern banking practice has reduced the need for drafts in many transactions. The economic objective remains similar: the buyer receives time to pay while the exporter obtains a bank-supported future payment obligation.
Usance Letter of Credit
"Usance LC" is a commercial term generally used for a documentary credit where payment occurs at a future determinable date.
A deferred-payment LC and an acceptance LC can therefore both fall within the broader concept of usance.
| Feature | Sight LC | Usance LC |
|---|---|---|
| Payment Timing | Following complying presentation and examination | At an agreed future maturity |
| Buyer Payment Period | Short | Extended |
| Seller Financing Requirement | Usually lower | Can be higher |
| Discounting Opportunity | Limited by short duration | Frequently more relevant |
A trader negotiating payment terms should therefore focus on the exact maturity formula rather than relying only on the word "usance."
Negotiation Letter of Credit
Negotiation has a specific meaning under UCP 600.
ICC guidance explains that negotiation involves a nominated bank purchasing drafts and/or documents under a complying presentation by advancing or agreeing to advance funds to the beneficiary before reimbursement becomes due.
Merely examining the documents does not constitute negotiation.
A letter of credit available by negotiation may combine payment security with export financing. The nominated bank evaluates the documentary presentation and relevant bank risk before deciding how it will handle the transaction.
Confirmed Letter of Credit
Confirmation changes which banks are obligated to the beneficiary.
The issuing bank already provides the core undertaking. A confirming bank adds its own undertaking to honor or negotiate a complying presentation.
Confirmation can be particularly valuable when the exporter has concerns about the issuing bank or its jurisdiction.
Example of LC Confirmation
A European exporter receives an LC issued by a bank in a market where the exporter has limited credit appetite. A highly rated European bank may add confirmation. The exporter can then rely on the confirming bank's undertaking subject to the conditions of the confirmed credit.
Confirmation carries a cost because the confirming bank assumes additional exposure. Pricing can reflect issuing-bank credit quality, country risk, tenor, currency and transaction size.
Unconfirmed Letter of Credit
An unconfirmed LC remains supported by the issuing bank's undertaking without a second bank adding confirmation.
An advising bank can authenticate and communicate the credit without becoming obligated to pay merely because it advised the instrument.
An exporter may accept an unconfirmed credit when the issuing bank is considered sufficiently strong and country risk is acceptable.
The choice between confirmed and unconfirmed concerns additional bank risk protection rather than the underlying payment timing.
Confirmation and Timing Are Separate Features
An LC can be confirmed at sight or confirmed with deferred payment. These descriptions address separate characteristics of the same instrument.
Transferable Letter of Credit
A transferable LC is designed for transactions involving intermediaries.
The first beneficiary can transfer all or part of the credit to one or more second beneficiaries where the credit expressly states that it is transferable. UCP 600 Article 38 governs transferable credits.
Consider a trading company that sells $5 million of agricultural products to an international buyer but purchases the goods from several producers.
The buyer opens a transferable LC in favor of the trader. The trader can arrange for qualifying portions of the credit to be transferred to its suppliers subject to the applicable conditions.
This can reduce the intermediary's need to fund the entire supplier payment from its own working capital.
Transferability must be expressly provided for in the credit.
Back-to-Back Letter of Credit
A back-to-back LC structure also supports intermediary trade, but the mechanics are different.
Two separate letters of credit are involved.
The buyer's bank issues the master LC in favor of the intermediary. The intermediary then asks its own bank to issue a second LC in favor of the underlying supplier.
1. Final Buyer Opens the Master LC
The buyer's bank issues the first credit in favor of the trader or intermediary.
2. Trader Receives the Master LC
The trader becomes beneficiary of the original documentary credit.
3. Trader Requests a Secondary LC
The trader asks its bank to issue another LC in favor of the underlying supplier.
4. Supplier Receives Its Own Undertaking
The supplier becomes beneficiary of the secondary credit rather than a transferred portion of the master LC.
Back-to-back structures can provide additional flexibility because the two credits are separate instruments. They also introduce greater documentary and operational complexity.
Transferable LC vs Back-to-Back LC
| Feature | Transferable LC | Back-to-Back LC |
|---|---|---|
| Number of Credits | One credit transferred | Two separate credits |
| Supplier | Second beneficiary | Beneficiary of secondary LC |
| Trader | First beneficiary | Beneficiary of master LC and applicant for secondary LC |
| Flexibility | More constrained by original LC | Greater ability to structure second LC |
| Complexity | Generally lower | Generally higher |
Revolving Letter of Credit
A revolving LC is designed for repeated transactions.
Instead of issuing a completely new documentary credit every time goods are shipped, the credit can restore or reinstate its availability according to agreed conditions.
The revolving mechanism can operate according to time or value.
A time-based credit might make a specified amount available each month, while a value-based structure may reinstate availability after each qualifying utilization.
Revolving credits can be useful for established trading relationships involving regular purchases of the same or similar goods.
Example of a Revolving LC
A manufacturer importing $1 million of raw material each month could potentially use a revolving structure instead of arranging 12 separate letters of credit during the year.
Red Clause Letter of Credit
A red clause LC allows the beneficiary to obtain an advance before shipment.
This changes the conventional sequence of documentary-credit financing. The seller can access part of the credit before producing the normal shipping documents.
ICC guidance distinguishes between clean or unsecured red clauses and documentary or secured red clauses. Documentary versions may require evidence such as warehouse receipts before the advance is made.
Red clause credits can therefore provide a form of pre-shipment financing.
Green Clause Letter of Credit
A green clause LC extends the concept further by connecting the advance to goods held in storage.
ICC guidance describes green clause structures as allowing advance payment while providing for storage of the goods in the bank's name as security.
This provides stronger collateral control than a completely unsecured pre-shipment advance.
Red and green clause credits demonstrate how an LC can combine payment security and trade financing within the same structure.
Electronic Letter of Credit
Digital presentation has created another important distinction.
Where electronic records are used, the credit may incorporate the eUCP, which supplements UCP 600 for electronic presentation.
An electronic LC retains the underlying relationship between applicant, issuer and beneficiary. The principal difference concerns how qualifying records can be created and presented.
This becomes increasingly relevant as trade documents such as electronic bills of lading move toward digital formats.
Direct-Pay Standby Letter of Credit
A direct-pay SBLC deserves separate treatment because it behaves differently from the conventional default-based standby.
ICC guidance identifies direct-pay standbys as instruments where payment may serve as the primary payment mechanism rather than waiting for a default in the usual standby sense.
These structures have been used in certain financing transactions where the beneficiary expects scheduled payments to occur through the standby.
Financial Standby Letter of Credit
A financial SBLC supports an obligation to pay or repay money.
Examples can include loan repayment obligations, lease payments or other defined financial liabilities.
The issuing bank treats the instrument as a contingent credit exposure to the applicant. Credit underwriting and reimbursement capacity therefore play a central role before issuance.
Performance Standby Letter of Credit
A performance SBLC supports contractual performance.
A contractor might provide one in favor of a project owner to support completion obligations. An equipment supplier may provide a performance standby connected to delivery or installation.
The distinction from a financial standby lies in the obligation being supported.
Performance SBLC
Supports contractual completion, delivery or other performance obligations.
Advance Payment SBLC
Protects qualifying advances paid before contractual performance is completed.
Advance Payment Standby
An advance-payment standby protects money advanced to the applicant before performance has been completed.
A project owner might advance 10% of a contract value to allow a contractor to mobilize. The contractor's bank issues an undertaking supporting repayment of the advance if the relevant conditions are met.
These instruments are common where suppliers need mobilization capital but buyers want bank-backed protection for the advance.
Which Letter of Credit Should a Company Use?
The correct structure follows the commercial transaction.
Payment After Shipment
A seller seeking secure payment after shipment may use an irrevocable documentary credit available at sight.
Extended Payment Terms
A buyer seeking additional time to pay may use a deferred-payment or usance LC.
Bank or Country Risk
An exporter concerned about the issuing bank or jurisdiction may request confirmation.
Intermediary Trade
A trader may consider a transferable or back-to-back LC structure.
Pre-Shipment Capital
A supplier requiring production financing may explore a red clause structure where supported by the relevant banks.
Contractual Security
A beneficiary seeking protection against contractual default may require an SBLC.
One LC Can Have Several Characteristics
A single instrument might be irrevocable, confirmed, transferable and available by deferred payment. Each description answers a different question about how the same credit operates.
A Practical Comparison of Letter of Credit Types
| Type | Main Purpose | Typical User |
|---|---|---|
| Documentary LC | Pay seller against documents | Importer and exporter |
| Sight LC | Prompt payment after complying presentation | Exporter |
| Deferred Payment LC | Future payment without immediate cash settlement | Buyer seeking terms |
| Acceptance LC | Future payment using accepted draft structure | Buyer and exporter |
| Confirmed LC | Add second bank payment undertaking | Exporter managing bank or country risk |
| Transferable LC | Allow first beneficiary to transfer credit | Trader or intermediary |
| Back-to-Back LC | Finance supplier through second LC | Trader or intermediary |
| Revolving LC | Support recurring shipments | Regular buyer and supplier |
| Red Clause LC | Provide pre-shipment advance | Supplier needing production capital |
| Green Clause LC | Pre-shipment advance with storage security | Commodity or inventory transaction |
| Standby LC | Protect against default or non-performance | Lender, buyer, landlord or project owner |
| Financial SBLC | Secure financial obligation | Lender or creditor |
| Performance SBLC | Secure contractual performance | Project owner or buyer |
| Advance Payment SBLC | Protect an advance paid to contractor | Buyer or project owner |
The Wording Matters More Than the Label
Companies should evaluate an instrument based on its actual wording and commercial structure rather than relying solely on the label requested by a transaction counterparty.
The credit should clearly define the amount, beneficiary, expiry, payment conditions, presentation requirements and applicable rules.
A poorly structured confirmed LC can create more execution risk than a properly structured unconfirmed LC issued by a strong bank. A transferable credit can also fail to solve an intermediary's financing requirement when its terms cannot be aligned with the supplier transaction.
The structure should therefore follow the underlying commercial flow.
The buyer needs to understand when its bank becomes obligated. The seller needs to understand exactly which documents create payment entitlement. Banks need to understand the applicant's reimbursement capacity and operational structure.
How Financely Approaches Letter of Credit Transactions
Financely works with companies seeking documentary letters of credit, standby letters of credit and structured trade finance facilities.
The process begins with the commercial transaction. We review the buyer and seller alongside the contract value, payment terms and required banking instrument. The analysis can also include shipment mechanics and collateral.
For intermediary trades, the financing structure may involve transferable or back-to-back letters of credit.
Transactions requiring deferred payment can involve usance or other structured documentary-credit solutions. Companies requiring contractual security may need an SBLC rather than a payment LC.
Our role can include transaction preparation, banking structure analysis and identification of suitable financing or issuance counterparties.
Every LC remains subject to the relevant bank's credit underwriting, compliance process and final approval.
Our Letter of Credit Process
1. Transaction Review
We review the underlying contract, counterparties, transaction value, payment terms and required banking instrument.
2. Structure Selection
We determine which documentary credit, standby or structured trade finance solution fits the commercial transaction.
3. Documentation
We organize the commercial, financial and transaction documentation required for review.
4. Counterparty Selection
We identify banks, trade finance providers or other counterparties whose mandates fit the transaction.
5. Structure and Term Review
We review proposed issuance conditions, collateral requirements, payment mechanics and financing terms.
6. Due Diligence and Execution
We coordinate the transaction through underwriting, compliance, documentation and final approval.
The Main Difference Between Letter of Credit Types
The easiest way to understand letters of credit is to separate the characteristics described by each term.
- Documentary vs standby describes the instrument's basic purpose.
- Sight vs deferred payment describes when payment occurs.
- Confirmed vs unconfirmed describes how many banks provide an undertaking.
- Transferable vs back-to-back describes how intermediaries and suppliers can be accommodated.
- Revolving describes how availability can be reinstated.
- Red and green clauses introduce pre-shipment financing features.
- ISP98 and UCP 600 describe rule frameworks rather than separate funding products.
Once these distinctions are understood, selecting the appropriate letter of credit becomes a question of transaction design rather than terminology.
Need a Letter of Credit or Trade Finance Facility?
Submit the transaction value, counterparties, underlying contract, requested instrument and required payment structure for review.
Request a Trade Finance ProposalTypes of Letters of Credit FAQs
What is the most common type of letter of credit?
The conventional irrevocable documentary letter of credit is widely used in international trade to provide payment against a complying presentation of specified commercial and shipping documents.
What is the difference between a documentary LC and an SBLC?
A documentary LC generally operates as the primary payment mechanism for a trade transaction. An SBLC generally provides security against a defined default, payment failure or contractual non-performance.
What is the difference between a sight LC and a usance LC?
A sight LC provides for payment following a complying presentation and documentary examination. A usance LC provides for payment at an agreed future maturity.
What is a confirmed letter of credit?
A confirmed LC includes an additional undertaking from a confirming bank in addition to the issuing bank's undertaking, subject to the terms of the credit.
What is the difference between transferable and back-to-back letters of credit?
A transferable LC involves one credit that can be transferred to a second beneficiary where expressly permitted. A back-to-back structure uses two separate letters of credit.
Can a letter of credit have several classifications?
Yes. A single credit can be irrevocable, confirmed, transferable and available by deferred payment because each term describes a separate feature of the instrument.
Can a usance letter of credit be discounted?
A beneficiary may be able to obtain financing or discounting against an eligible future bank payment undertaking. Availability and pricing depend on the issuing bank, tenor, transaction structure and financing provider.
Does Financely issue letters of credit?
Financely acts as a financial advisor and arranger. Any letter of credit or standby letter of credit is issued by the relevant bank or financial institution subject to its underwriting, compliance requirements and approval.
Financely acts as an independent financial advisor and arranger. Financely is not a bank or direct lender and does not guarantee letter of credit issuance, financing or approval. Banking instruments and financing facilities remain subject to underwriting, KYC, AML, sanctions screening, documentation, collateral requirements where applicable and final approval by the relevant bank or capital provider.
About Financely
We Provide Private Credit Trade and Project Finance Advisory for Sponsors and Borrowers
Financely is an independent capital adviser focused on trade finance, project finance, Commercial Real Estate, and M&A funding. We structure, underwrite, and place transactions through regulated partners across banks, funds, and insurers. Engagements are best-efforts, not a commitment to lend, and remain subject to KYC, AML, and approvals.