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What is an Irrevocable Letter of Credit?

Irrevocable Letter of Credit provides security of payment to its beneficiary who is usually an exporter. In this blog, learn more about meaning and benefits of ILOC.
Irrevocable Letter of Credit
A Letter of Credit (LC) is a payment method used by businesses – it is a document issued by a bank or a financial institution that guarantees that the exporter will receive payment from the importer on time for the full or remaining amount. Among the many types of LCs, an Irrevocable Letter of Credit (ILOC) is a guarantee for payment issued by the importer’s bank for the transaction of goods between importer and exporter, which cannot be cancelled during any specified time period. ILOCs are mostly used to facilitate international trade and offer additional risk protection for the exporter by providing a guarantee of payment from both the importer and exporter’s banks.

What is an Irrevocable Letter of Credit?

As the name suggests, an Irrevocable Letter of Credit cannot be cancelled or amended without the explicit agreement of all parties (importer, exporter and issuing bank). This LC is an official correspondence from the bank that it guarantees payment for goods being purchased by the importer who requests the Letter of Credit. The issuing bank is bound by the commitments mentioned and cannot change any terms of an ILOC once issued.

The ILOC is irrevocable and is frequently used for large transactions. It facilitates international trade because of the additional credit risk involved when two parties are unfamiliar with each other. ILOC helps exporters with receiving payment because this is a guarantee by the issuing bank (importer’s bank) that payment will be made by the bank if the importer fails to do so1.

Template of an Irrevocable LC

• An Irrevocable Letter of Credit (Irrevocable Letter of Credit) represents a commitment from a bank to ensure payment for purchased goods and services, and it remains unalterable within a defined timeframe.
• Irrevocable Letter of Credits are primarily used to facilitate international trade transactions.
• A confirmed Irrevocable Letter of Credit increases the exporter’s risk protection since it guarantees payment from both the importer’s and exporter’s banks.
• An Irrevocable Letter of Credit boosts the creditworthiness of importers by leveraging the institution's financial stability.
• An Irrevocable Letter of Credit can encompass precise details, including insurance demands, incoterms, compliance with government regulations or documentation prerequisites.

Conditions associated with an Irrevocable Letter of Credit

The conditions of ILOC are fixed and cannot be amended without the consent of the involved parties. The stakeholders (importer and exporter) have to agree on all the clauses mentioned in this letter under different conditions. This letter specifies more provisions about security, blacklisting and boycott, if there is any misconduct. Besides terms and conditions, authority is also defined for disbursements in different situations, possession of goods and acknowledgment of documents in conformity with terms and conditions of the credit2.

How does an Irrevocable Letter of Credit work?

Step 1

An ILOC offers assurance to importers and exporters with the support of their respective banks. The buyer is not required to make any payments until the shipment is dispatched, and the seller will receive their payment once the specified conditions in the letter are met. The functioning of an Irrevocable Letter of Credit is governed by the information provided in the letter and the accompanying documents. Nevertheless, the fundamental components remain consistent in every Letter of Credit.

Step 2

Once the cargo has been dispatched, a package of documents outlining shipment particulars will be forwarded to the importer's bank in accordance with the mutually agreed terms and conditions.

Step 3

Subsequently, the importer's bank transmits these documents to the seller's bank for examination and settlement. The bank then transfers the Letter of Credit (LC) to the seller and any essential documentation needed for the collection process upon the shipment's arrival.

How to get an Irrevocable Letter of Credit?

Step 1

To obtain an ILOC, you must approach a bank.

Step 2

The bank will assign a representative with prior experience in international trade and related compliance.

Template of an Irrevocable LC

An Irrevocable Letter of Credit usually includes the following3:
• Name of the issuing bank or financial institution
• Letter of Credit number
• Date of issue
• Applicant details and amount
• Date and place of expiry
• Conditions of the transaction
• Authorized signature of the banking professional

Benefits of an Irrevocable Letter of Credit

Benefits for importers

A company that is successful in obtaining a letter of credit is able to verify that the financial institution is willing to guarantee the transaction amount. The importer is assured of receiving the entire amount agreed upon, which builds confidence in the transaction.

Benefits for sellers

If the importer cannot pay the entire amount owed, the seller will receive money from the bank that issued the letter of credit. The seller may occasionally choose a banker, and the payment will be made to that banker. A seller may designate an alternate recipient to receive payment if the terms of the letter of credit allow such transfers.

Cost of obtaining an Irrevocable Letter of Credit

The cost of an Irrevocable Letter of Credit depends on the type of ILOC used, customer credit history, tenure, safeguarding clauses and various other factors4.

Irrevocable LC is used to ensure safe and secure payments that also benefits both – importer and exporter. With e-commerce exports, reaching international customers and receiving payments has become easier and simpler than before. Amazon Global Selling not just enables you to export to 200+ countries and territories but also helps you receive payments directly to your bank account in INR or other currency of your choice.

Alternatives to Irrevocable Letter of Credit

Standby Letter of Credit

The bank issues a Standby Letter of Credit to the exporter, which guarantees that if the importer (the bank's client) defaults on the payment, the bank will uphold its commitment and pay the exporter.

Purchase Order Financing

In this case, a financing company pays the supplier of goods needed to fulfil a purchase order. It collects payment from the importer who initiated the purchase order and then provides the supplier with the cash to complete the purchase order.

Invoice factoring

It helps exporters fill the gap between when an invoice is created and when the importer will pay by immediate access to cash to cover operational costs and other organisation expenses.

An Irrevocable Letter of Credit is an important financial instrument in international trade. An ILOC becomes an extremely important document when there is international trade between two parties who are unfamiliar with each other and are transacting across borders. Until and unless all parties agree, the terms and conditions of an Irrevocable Letter of Credit cannot be cancelled or modified, and this, in turn, provides payment security for exporters and assurance to importers.

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Frequently Asked Questions

What is a Clean Irrevocable Letter of Credit?
A clean LC allows the beneficiary of the credit to draw the bill of exchange without any extra documentation. A clean LC is irrevocable till the period of renew.
What is the role of the issuing bank in an Irrevocable Letter of Credit?
Even the issuing bank alone does not have the authority to make amendments to the terms of the ILOC unless all parties involved in the ILOC explicitly agree on cancelling or modifying any term of the Irrevocable Letter of Credit.
What is the difference between a revocable Letter of Credit and an Irrevocable Letter of Credit?

Revocable Letter of Credit

• After its issue, a Revocable Letter of Credit can be modified, amended, or cancelled by the issuing bank without the permission of the beneficiary.
• It can be considered as a limited security payment method for the beneficiary as it is subjected to amendment or cancellation without the consent of the beneficiary.
• The bank of the exporter’s country is not informed about any changes or amendments done in the Letter of Credit and hence there is a risk of payment being refused by the issuing bank.

Irrevocable Letter of Credit

• An Irrevocable Letter of Credit is a type of letter credit which does not allow the issuing bank to modify, amend, or cancel it without giving an acknowledgement to the beneficiary.
• This Letter of Credit provides much security to the beneficiary.
• The bills drawn under an Irrevocable Letter of Credit will be honoured by the issuing bank, once all the conditions of the LC agreement have been met.
Is an LC always irrevocable?
No, LC are not always irrevocable. There are revocable LCs as well.
Who can issue an Irrevocable Letter of Credit?
An Irrevocable Letter of Credit is issued by a commercial bank (the importer’s bank) that makes sure that the amount is received by the exporter on time.
Can an irrevocable LC be cancelled?
An irrevocable LC is the Letter of Credit cannot be cancelled pr amended without the consent of all parties concerned. This is where the terms and conditions and the amount are renewed or restricted without specific amendments to the credit being needed.
Published on November 28, 2022.

Sources:
1. https://www.unionbankofindia.co.in/pdf/hkb_20_auditpolicylettersofcredit.pdf
2. https://agriexchange.apeda.gov.in/Ready%20Reckoner/LETTER_OF_CREDIT.aspx
3. https://www.investopedia.com/terms/i/iloc.asp
4. https://www.tradefinanceglobal.com/letters-of-credit/standby-letter-of-credit-sblc/
5. https://www.emeriobanque.com/blogs/revocable-and-irrevocable-letter-of-credit

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