Irrevocable Letter of Credit

Definition

An Irrevocable Letter of Credit (ILOC) is a type of letter of credit that cannot be altered or canceled without the explicit consent of all parties involved—the issuing bank, the buyer (applicant), and the seller (beneficiary). It is often used in international trade to assure sellers that they will receive payment for the goods or services supplied, provided the stipulated conditions are adhered to.

Key Features:

Non-Cancellable: Once issued, an ILOC is binding and cannot be modified or revoked without agreement from all parties.
Guarantee of Payment: ILOC guarantees that the seller will receive the payment as long as they meet the documentary requirements specified.
International Trade: Commonly used in international commerce to mitigate risks related to payment and performance.

Examples

International Machinery Export: A U.S. manufacturer exporting machinery to a distributor in Brazil receives an ILOC from a Brazilian bank. The bank guarantees that payment will be made according to the contract terms if the U.S. seller meets the shipment and documentation standards.
Agricultural Products: An Argentine soybean exporter selling to a European buyer gets paid through an ILOC issued by a European bank, ensuring payment once the grain is shipped and documents are confirmed.

Frequently Asked Questions (FAQs)

What is the difference between an irrevocable and a revocable letter of credit?

An irrevocable letter of credit cannot be altered or canceled once it is issued without the consent of all parties involved, while a revocable letter of credit can be amended or canceled by the issuing bank at any time without prior notice to the beneficiary.

How does an irrevocable letter of credit protect the seller?

It ensures that payment will be made as long as the terms and conditions outlined in the letter of credit are met. This provides security against buyer default, reducing the risk for the seller.

Who issues an irrevocable letter of credit?

ILOCs are issued by banks or financial institutions on behalf of the buyer, guaranteeing payment to the seller under specified conditions.

Can an irrevocable letter of credit be transferred?

It can be transferable if it is explicitly stated as such in the terms of the letter of credit. This means the beneficiary can transfer part or all of the payment to another party.

What documents are generally required for an irrevocable letter of credit?

Typically, documents like commercial invoices, bills of lading, packing lists, insurance documents, and certificates of origin are required to comply with the letter of credit terms.

Letter of Credit (LOC): A broader category of financial instruments that includes both revocable and irrevocable letters of credit, used to guarantee payment in trade deals.
Documentary Collection: An arrangement whereby the seller uses their own bank to collect payment from the buyer’s bank for shipped goods.
Trade Finance: Financial products and instruments that help companies trade internationally, including letters of credit, documentary collections, and trade credit insurance.
UCP (Uniform Customs and Practice for Documentary Credits): A set of rules that apply to all LCs, outlining the responsibilities of banks to facilitate international trade finance.

Online Resources

Suggested Books for Further Studies

“Principles of Banking” by GARP (Global Association of Risk Professionals)
“Handbook of International Trade and Finance: The Complete Guide for International Sales, Finance, Shipping and Administration” by Anders Grath
“Trade Finance: A Complete Guide” by Erik Hofmann, Oliver Belin

Accounting Basics: “Irrevocable Letter of Credit” Fundamentals Quiz

### What is the primary characteristic of an irrevocable letter of credit? - [ ] It can be canceled at any time by the issuing bank. - [x] It cannot be changed or canceled without the consent of all parties. - [ ] It requires the buyer to make a security deposit. - [ ] It is only valid for domestic transactions. > **Explanation:** An irrevocable letter of credit cannot be changed or canceled without the agreement of all involved parties, offering security to the seller. ### Which entity typically issues an irrevocable letter of credit? - [ ] The buyer - [x] A bank or financial institution - [ ] The seller - [ ] A trade association > **Explanation:** Banks or financial institutions typically issue irrevocable letters of credit on behalf of the buyer to guarantee the seller's payment. ### What type of transactions often use irrevocable letters of credit? - [ ] Real estate deals - [ ] Employment contracts - [x] International trade - [ ] Personal loans > **Explanation:** Irrevocable letters of credit are commonly used in international trade to mitigate payment risks. ### What must the seller provide to receive payment via an irrevocable letter of credit? - [x] Specific documents outlined in the letter of credit - [ ] A personal guarantee from the buyer - [ ] An initial deposit - [ ] A notarized contract > **Explanation:** The seller must provide the documents specified in the letter of credit, such as invoices and shipping documents, to receive payment. ### How does an irrevocable letter of credit benefit the buyer? - [ ] It ensures the goods are delivered before payment is made. - [ ] It allows partial payment before delivery. - [x] It assures the buyer's commitment and financial reliability to the seller. - [ ] It reduces the interest rates on loans. > **Explanation:** An irrevocable letter of credit assures the seller that the buyer is committed and financially reliable, reducing transaction risk. ### Can an irrevocable letter of credit be transferred to another party? - [ ] No, it is strictly non-transferable. - [ ] Yes, it can always be transferred. - [x] Yes, if it is explicitly stated as transferable. - [ ] Only with legal permission. > **Explanation:** An irrevocable letter of credit can be transferred to another party only if it explicitly states that it is transferable. ### What set of rules commonly governs international letters of credit? - [ ] Federal Trade Commission (FTC) regulations - [x] Uniform Customs and Practice for Documentary Credits (UCP) - [ ] International Financial Reporting Standards (IFRS) - [ ] Foreign Corrupt Practices Act (FCPA) > **Explanation:** The Uniform Customs and Practice for Documentary Credits (UCP) is a set of rules commonly governing international letters of credit. ### What happens if the seller does not meet the terms of the irrevocable letter of credit? - [ ] The buyer still has to make the payment. - [ ] The seller can modify the terms retroactively. - [x] Payment is not made to the seller. - [ ] The bank will charge additional fees. > **Explanation:** If the seller does not meet the terms of the irrevocable letter of credit, the payment will not be made. ### What primary risk does an irrevocable letter of credit mitigate? - [ ] Risk of fluctuating exchange rates - [x] Risk of non-payment by the buyer - [ ] Risk of losing the goods in transit - [ ] Risk of legal disputes > **Explanation:** An irrevocable letter of credit primarily mitigates the risk of non-payment by the buyer, providing the seller financial assurance. ### What document is typically not required to claim payment under an irrevocable letter of credit? - [ ] Commercial invoice - [ ] Bill of lading - [ ] Certificate of origin - [x] Buyer's purchase order > **Explanation:** A buyer's purchase order is typically not required to claim payment under an irrevocable letter of credit.

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