A transferable letter of credit is a credit facility that the first beneficiary can transfer to another party or the second beneficiary. Such a financial guarantee is applicable when the sellers of goods are agents/dealers and are not the suppliers or manufacturers themselves.
This LC gives the sellers the authority to advise the bank to make the credit available wholly or in part to one or more second beneficiaries.
In this arrangement, the first beneficiary has the right to pass on the available credit to the secondary beneficiary, which may involve more than one party. This is only possible when the buyer marks the LC as transferable to the issuing bank.
Why is a Transferable Letter of Credit Required?
Most transfers involve a beneficiary of the LC, usually a seller, who has a pending sale but cannot complete the merchandise order from the manufacturer on an open account. Export brokers generally use transferable LCs. By transferring a portion of the export LC to the manufacturer, the broker can leverage the buyer's banker's credit. This is done by providing the manufacturer assurance of payment if they comply with the terms and conditions of the transferrable LC.
How to Apply for a Transferable Letter of Credit?
The process of applying for a transferable LC is almost the same as applying for a loan. The buyer must submit an LC application that includes their credit profile details. The bank will then evaluate the credit score and the buyer's financial stability in the underwriting process. After the approval, the LC will mention that the bank is willing to issue a loan for a certain amount to the buyer if needed to cover the order payment with the seller.
How does a Transferable Letter of Credit Work?
The transferable LC creates a redeemable facility between all the parties involved. The buyer of the goods requests a bank to be an intermediary in the process. It means that the bank is assuring the seller that the buyer will pay them. This is an essential step in the transaction because the seller can process the order further only after possessing the guarantee of payment. The LC offers them that assurance.
A transferable LC includes the provision of extending the credit to the second beneficiary. So, in this instance, the second beneficiary is responsible for paying off the loan.
Transferable Letter of Credit Insurance Calculation
The percentage for which the insurance cover must be effected on a transferable LC can be increased to provide the amount of cover mentioned in the credit. The insurance policy coverage is up to 110% of the invoice value, in the currency of invoice in the banks' name, and covers all risks mentioned in the standard agreement clause.
If a shipment on deck arrangement is permitted under the LC, the insurance must also cover the risk of discarding the goods or the goods getting washed overboard. The validity of the insurance should align with the LC or contract terms.
Transferable Letter of Credit - Charges
All charges incurred in respect of a transfer must be paid by the first beneficiary unless agreed otherwise at the time of transfer. These charges include commissions, fees, costs, and/or other expenses.
Transferable Letter of Credit - Example
Kento, an Italian firm, places an order to United Services, an American company. United Services requests Kira Ltd to issue a transferable LC, allowing them to avail credit facility from its supplier based on this letter.
Kento writes to its bank to issue a transferable LC. If the bank agrees to the request, United Services can issue the transferable LC to its supplier, i.e., the secondary beneficiary.
Transferable Letter of Credit - Format
The transferable LC process is as follows:- Issuance of LC Shipping of goods Providing documents to the confirming bank Settlement of payment from importer and possession of goods
Sample of Transferable Letter of Credit-- SWIFT Format
Transferable Letter of Credit V/S Back-to-Back Letter of Credit
A back-to-back LC is used as an alternative to a transferable LC. It offers the agent/exporter/first beneficiary the right to use the original LC as security in favor of the secondary beneficiary, that is, the supplier.
A back-to-back LC also acts as a credit document but with a bit of a difference. Here the agent/exporter/first beneficiary can request the buyer to issue a transferable LC to endorse it further to the supplier or the secondary beneficiary. If the LC is not transferable, it cannot be handed over to the supplier.
Difference between Transferable Letter of Credit and Non-Transferable Letter of Credit
An LC can be transferable or non-transferable. In case of transferable credit, the word ‘transferable’ is mentioned on the LC. However, in the absence of such an indication, the LC is deemed to be non-transferable.
As read earlier, the first beneficiary (the exporter) can ask the paying bank to make the credit available wholly or in part to one or more party or second beneficiaries in a transferable LC. Here, the second beneficiary can be an export manufacturer or an export trader.
The first beneficiary or the exporter must pay all the charges involved in the process, such as the commission, fees, costs, and other expenses unless both parties have agreed otherwise. The second beneficiary cannot transfer the LC to any third beneficiary but can re-transfer the LC to the first beneficiary.
Fractions of a transferable LC can be transferred separately. However, the sum of the fractions of transfer must not exceed the total amount of the credit. Also, there must be a mention of permission for partial shipment in the LC.
In a non-transferable LC, the beneficiary cannot transfer the credit to another beneficiary. The beneficiary may assign the proceeds they are entitled under the LC but do not have the right to perform under the LC.
FAQs on Transferable Letter of Credit (LC)
1. What does transferring bank in LC mean?
Transferring bank in LC is a nominated bank that transfers the credit. A transferring bank can also be a bank authorized explicitly by the issuing bank to transfer the credit. An issuing bank can also be a transferring bank.
2. How many times can a transferable LC be transferred?
A transferable LC can only be transferred to one or more second beneficiaries, but it cannot be transferred further.
3. Can a transferable LC be confirmed?
LCs are based on conditional commitments. The banks prepare them at the importers' request. The LC guarantees that the importing party will pay the cost of goods to the exporter but only when the conditions are met and the documents mentioned on the LC are delivered correctly. In other words, a transferable LC itself is a confirmation that the payment will be made subject after the specific terms and conditions are fulfilled. The issuing bank can confirm the authenticity of an LC.
4. Can a transferable LC be discounted?
LC discounting acts as financial security for the import or export businesses or both. This funding option can be availed to fulfill financial requirements. It can be used, for instance, when the importer wants to extend the payment term but the exporter insists on immediate payment or when the importer fails to pay on the due date.
5. Is a transferable LC safe?
Yes, a transferable LC is safe and secure. The most significant advantage of using a transferrable LC is that it guarantees the supplier that they will receive their dues. With a transferable LC, an importer or an exporter can transact with their international trade partners securely without even knowing them in person.
6. What is a non-transferable LC?
A non-transferable LC is a document of credit that a beneficiary cannot assign, either partially or entirely, to any other party. It is issued in favor of a particular beneficiary, which is usually the seller in trade deals. The letter remains non-transferable to anyone other than the beneficiary for financial security and convenience.
7. What is the risk associated with a transferable LC?
In some cases, the seller may find it challenging to fulfill the terms of the LC and may request the buyer to amend the LC due to the following reasons.
- The seller cannot meet the agreed shipment schedule
- The stipulations regarding freight costs are not acceptable
- Exchange rate fluctuations are making the trade less profitable or can even lead to losses
- The quantity of product ordered does not match the agreed terms and expectations
- The specified documents are difficult or impossible to obtain
When problems arise so late in the trade process, the buyer's and seller's banks try to negotiate. This may result in a delay in executing and completing the transaction. It is also important to note that if the documents are not in line with the specifications of the LC, the buyer's issuing bank is not obliged to make the payment. As most LCs are irrevocable, it may not be easy to make amendments at times.
8. What cannot be changed while transferring the LC?
The terms and the conditions mentioned in the original LC cannot be changed while transferring the LC.
9. How many beneficiaries can there be in a transferable LC?
A transferable LC can have a first beneficiary and one or more second beneficiaries.
10. What can be changed in a transferable LC?
The following can be changed in a transferable LC:-
- The amount of the LC
- The unit price of the goods
- The time of shipment
- The last date for the presentation of documents
- The expiry date of the LC
11. What is a transferable standby LC?
A transferable standby LC is a legal document that guarantees a bank's payment commitment to a seller. The guarantee stands even if the buyer defaults on the agreement due to some reasons or circumstances.