How Do Back-to-Back Letters of Credits Work?

Back-to-back letters of credit enable a seller to receive payment from the buyer's bank while using the same letter of credit to secure payment for the supplier involved in the transaction.

Oct 17, 2024 at 03:11 am

How Do Back-to-Back Letters of Credits Work?

1. Issuance of the Master Letter of Credit (MLC)

• The buyer's bank (issuing bank) issues a MLC promising payment to the seller's bank (advising/confirming bank) upon the presentation of certain documents.

2. Confirmation or Advice of the MLC

• The advising/confirming bank receives the MLC and either confirms its authenticity and irrevocability (confirmed MLC) or simply advises the seller of its existence (advised MLC).

3. Issuance of the Back-to-Back Letter of Credit (BBC)

• The seller's bank (issuing bank for the BBC) issues a BBC to the supplier (beneficiary of the BBC). This BBC guarantees payment to the supplier upon the presentation of specified documents (e.g., shipping documents, invoices).

4. Connection Between the MLC and BBC

• The BBC is linked to the MLC through a specific clause, typically stating that the BBC is "authorized but not guaranteed by" the MLC. This means that the BBC is valid and will be honored only if the MLC is valid and honored.

5. Presentation of Documents

• The supplier presents the required documents under both the BBC and the MLC to the seller's bank (confirming bank of the BBC).

6. Review and Payment

• The seller's bank reviews the documents for compliance with both the BBC and the MLC.
• If all documents are in order, the seller's bank pays the supplier under the BBC.
• The seller's bank then presents the same documents to the buyer's bank (issuing bank of the MLC) for reimbursement under the MLC.

7. Reimbursement

• If the buyer's bank finds the documents satisfactory, it reimburses the seller's bank the amount paid to the supplier under the BBC.

Benefits of Back-to-Back Letters of Credit:

• Reduced Risk for the Buyer: The buyer has the security of the MLC, ensuring that the supplier will receive payment.
• Facilitated Payment Chain: The BBC allows for multiple parties to be involved in the transaction, ensuring timely and efficient payment.
• Improved Trade Relationships: The use of a BBC can foster trust and cooperation between the buyer, seller, and supplier.