What Is a Transferable Letter of Credit?

What Is a Transferable Letter of Credit?

Let me explain what a transferable letter of credit is. It's a type of letter of credit that lets the first beneficiary transfer some or all of the credit to another party, which then becomes the secondary beneficiary. You, as the party that first receives this letter from the bank, are the primary beneficiary, and the one who applied for it is the applicant. I see these used often in business deals to make sure suppliers or manufacturers get paid, serving as an alternative to upfront payments.

Key Takeaways

Here's what you need to know right away. A transferable letter of credit allows the initial beneficiary to transfer part or all of the due credit to someone else. These are common in business setups to guarantee payment to suppliers or manufacturers. Besides the bank, the main parties are the applicant (that's the buyer), the first beneficiary (like a retailer or broker), and the second beneficiary (such as a supplier or manufacturer).

How Transferable Letters of Credit Work

You should understand that a letter of credit is basically a document from a bank guaranteeing that a seller gets the money a buyer promised for goods or services. If the buyer doesn't pay, the bank steps in.

For instance, sellers of manufactured goods often demand a letter of credit to ensure they get paid on time and in full before fulfilling an order. The buyer applies to a bank for this and pays a fee for the risk the bank takes on.

These are frequently used in import-export deals. As the U.S. Department of Commerce notes, letters of credit are secure for international traders, especially when credit info on a foreign buyer is hard to get, but you're okay with the buyer's bank. It protects the buyer too, since payment only happens after goods are shipped as agreed.

A transferable one adds a clause allowing transfer of some or all the credit to a secondary beneficiary, like a supplier the first beneficiary relies on. Here, the first beneficiary acts as a middleman between supplier and buyer. You can have multiple secondary beneficiaries.

Like other letters of credit, transferable ones apply to both domestic and international commerce.

Obtaining a Transferable Letter of Credit

You can get letters of credit from many banks, especially those with international operations.

The process to get approved is like applying for a loan. As the buyer, you submit a credit application with your income, assets, debts, and transaction details. The bank underwrites it, assessing your risk and deciding on approval and terms.

Remember, with a letter of credit, you're not borrowing money directly. It's a guarantee that the bank will loan you the amount if needed to cover the seller's payment.

Transferable Letter of Credit vs. Confirmed Letter of Credit

Let me compare this to a confirmed letter of credit. A transferable one can be easier for you as a buyer since you only deal with one bank.

With a confirmed letter, you need two: the second confirms the first, often required if the seller worries about the first bank's default. The second bank is usually one the seller trusts, common in international trade across countries.

What Is a Commercial Letter of Credit?

A commercial letter of credit means the bank pays the beneficiary directly—usually the seller—once they've met their obligations, releasing the buyer's funds. This differs from standby letters, where the bank pays only if the buyer fails.

What Is a Back-to-Back Letter of Credit?

A back-to-back letter involves two separate letters for the same deal with a middleman. The buyer gives one to the middleman for payment assurance, and the middleman uses that to get another for their supplier, ensuring everyone gets paid.

What Is a Revolving Letter of Credit?

A revolving letter of credit provides a credit amount usable over multiple transactions, ideal for ongoing buyer-seller relationships like importers and exporters, so you don't need a new one each time.

What Is a Credit Facility?

A credit facility is a loan where you access funds as needed, not all at once. Revolving credit is a type of this.

What Does a Letter of Credit Cost?

Banks charge a percentage of the guaranteed amount, varying by your creditworthiness. From what I've seen on lender sites, fees range from about 0.75% to 2%.

The Bottom Line

Letters of credit are key in transactions between buyers and sellers, especially across borders or without established trust. Transferable ones ensure sellers and their suppliers get paid upon delivery. You pay for them as a buyer, but they enable deals that might not happen otherwise.