In international trading, there is a lack of personal contact, distance, and separate law in each country, etc.
To make foreign trading secure, a letter of credit is a well-structured way of payment mechanism. There are 3 parties involved in the letter of credit (LC) process;
- An importer that request the bank for the issuance of LC
- Issuing Bank (Applicant’s or importer’s bank that issue the underwriting letter)
- Exporter or Beneficiary
A letter of credit has its pre-defined terms & conditions that are mutually decided by the trading partners. The bank acts as a guarantor that the seller would receive its payment on the decided date.
In an LC agreement due to some reasons, the bank can amend the letter of cancellation it which is known as a revocable letter of credit. Let’s see the in-depth meaning and working of a revocable letter of credit.
Revocable Letter of Credit is a type of LC in which a letter can be altered or canceled by the issuing bank without giving advance notice to the beneficiary.
The bank can modify the terms of the letter or terminate LC after its insurance at any time and for any reason.
When the letter is canceled or changed without the permission of the beneficiary this becomes disadvantageous for the exporter.
Unexpected termination of LC is unprofessional, unethical, and also causes financial loss. Due to permission, fewer amendment conflicts may arise between the sellers and buyers.
Sudden changes in the contract may drag the importers and exporter in the legal court to resolve the dispute.
Example of Revocable Letter of Credit
Under a revocable letter of credit, if the seller team was unable to deliver the goods within the required time period, then the seller would simply change the shipment date that suits them. In this case, the buying side is powerless.
Therefore, irrevocable LC is more preferred by the buyers because the seller is required to apply for a shipment date extension in case he is unable to deliver on the decided date.
Types of Revocable Letter of Credit
The revocable LC is divided into two subtypes;
In secured revocable LC the applicant gave some personal warranty or mortgage security to get the letter of credit. In other words, applicant assets are used to secure the LC.
As the name suggests there is no security in the unsecured revocable letter of credit. The bank checks at the applicant’s credit score or history to issue the letter of credit.
Whether the agreement is secured or unsecured, it is important to note that the bank always has the power to revoke the revocable letter of credit.
Conditions at Which Bank Can Revoke the Revocable Letter Of Credit
Revocable LC allows the bank to change the terms without involving the trading parties. The terms amendment and cancellation of LC is possible on bank decision due to several reasons;
- The beneficiary may find the trading is not doable further due to LC terms & conditions
- The seller may be getting enough capital to perform an agreement under the letter of credit.
- International trade may get canceled due to deteriorated market conditions.
- Political tensions between the countries could become another reason for revoking LC.
- In case the unit price is increased after the opening of LC and the beneficiary may think this deal is no more profitable for him
- In some cases, the seller may modify and cancel the agreement to gain personal benefits or violate it due to some fraud.
Why Revocable Letter of Credit is Not Preferred?
No trading partners want to change or terminate their deal without any solid cause. There is a rarity that a revocable letter of credit is used due to numerous reasons. Firstly, there is a risk of no-payment.
The purpose of LC might get neglected in it. Secondly, there is no protection in such an agreement because the modification and cancellation is done before informing the other party.
The revocable LC only facilitates the sellers there is no security for the buyers that is the most negative point of this agreement.
In a Revocable Letter of Credit, the bank uses the authority to alter or cancel the letter of credit contract without taking beneficiary consent at any point in time.
t is rarely used because it does not provide protection or security in foreign trading. It is recommended to take expert advice before stepping into any financial deals.