What is a Revocable Letter of Credit?

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A revocable letter of credit (LC) is a financial instrument that provides a conditional payment guarantee from a bank to a beneficiary on behalf of a buyer. The primary purpose of a revocable LC is to facilitate international trade by minimizing the risk of payment default. In this post, we will discuss the basics of revocable letters of credit, their advantages and disadvantages, and how they are different from irrevocable letters of credit.

Basics of Revocable Letters of Credit

A revocable letter of credit is a type of LC that can be amended or canceled by the issuing bank at any time without the consent of the beneficiary. This means that the seller does not have a secure payment guarantee, and the buyer can easily cancel the payment or modify the terms of the LC.

Revocable LCs are rarely used in international trade transactions now-a-days due to their limited protection for the seller. They may be used in transactions between parties that have an established business relationship and trust each other. In such cases, the seller may accept a revocable LC because they are confident that the buyer will not default on payment.

Advantages of Revocable Letters of Credit

The main advantage of a revocable LC is that it provides flexibility to the buyer. The buyer can modify or cancel the LC without the consent of the seller, which can be useful if there are changes in the transaction or if the buyer has concerns about the seller’s performance.

Another advantage of a revocable LC is that it can be less expensive than an irrevocable LC. Since the bank providing the LC has less risk, they may charge lower fees than they would for an irrevocable LC.

Disadvantages of Revocable Letters of Credit

The primary disadvantage of a revocable LC is that it provides limited protection for the seller. Since the buyer can cancel or modify the LC at any time, the seller may not have a secure payment guarantee. This can make it difficult for the seller to secure financing or to negotiate favorable terms with their suppliers.

Another disadvantage of a revocable LC is that it may not be accepted by all sellers. Many sellers prefer to work with irrevocable LCs because they provide a more secure payment guarantee. If a seller does not accept a revocable LC, the buyer may need to find alternative payment methods or negotiate with the seller.

Difference Between Revocable and Irrevocable Letters of Credit

The main difference between a revocable and an irrevocable LC is the level of protection they provide to the seller. An irrevocable LC provides a secure payment guarantee to the seller, while a revocable LC does not.

An irrevocable LC cannot be modified or canceled without the consent of all parties involved, including the seller. This means that the seller has a secure payment guarantee, and the buyer cannot change the terms of the LC without the seller’s approval.

In contrast, a revocable LC can be modified or canceled by the buyer or issuing bank without the consent of the seller. This means that the seller does not have a secure payment guarantee, and the buyer can easily cancel the payment or modify the terms of the LC.

Conclusion

Revocable letters of credit are a type of financial instrument that provides a conditional payment guarantee from a bank to a beneficiary on behalf of a buyer. They are rarely used in international trade transactions due to their limited protection for the seller. However, they can be useful in transactions between parties that have an established business relationship and trust each other.

While a revocable LC provides flexibility to the buyer and may be less expensive than an irrevocable LC, it can also be less attractive to sellers. An irrevocable LC provides a secure payment guarantee to the seller, and is therefore preferred in most international trade transactions. Sellers who do accept revocable LCs may be at a disadvantage when negotiating with their suppliers or securing financing.

When considering the use of a revocable LC, it is important to carefully weigh the advantages and disadvantages. In some cases, the flexibility provided by a revocable LC may be worth the additional risk to the seller. However, in most international trade transactions, an irrevocable LC is the preferred option for both buyers and sellers.

UCP 600 which came into effect on 1st July 2007 has removed the reference to revocable credits. UCP 600 article 3 states that a credit is irrevocable even if there is no indication to that effect. This means an LC will be considered as irrevocable even if nothing is mentioned on it.

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