What is a Revolving Letter of Credit?

A revolving letter of credit is a type of letter of credit in which the amount of the credit revolves upon shipment of goods, presentation of documents or after a specific time frame. In other words when any of the above mentioned events occurs, the amount of the letter of credit gets replenished automatically. There is no requirement of a separate amendment for this revolvement.

A revolving letter of credit is often used in international trade, where buyers and sellers have ongoing relationships and need to make multiple transactions. The use of a revolving letter of credit can provide flexibility and convenience for both parties, as it eliminates the need to apply for a new letter of credit for each transaction.

Table of Contents

Types of revolving letter of credit

There are two main types of revolving letters of credit. These are classified primarily on the basis of whether the revolvement of the amount is dependent on time or dependent on value.

Revolvement dependent on time

In a revolving letter of credit where revolvement is dependent on time, a specific amount can be utilized within a defined period. However, the utilization has to be done within the validity of the letter of credit.

e.g. a revolving letter of credit for USD 10000 valid for 3 months

A revolving letter of credit where revolvement is dependent on time may be either Automatic/Non-automatic or Cumulative/Non-Cumulative. We have discussed these in the below section.

Revolvement dependent on value

In a revolving letter of credit where revolvement is dependent on value, the amount of the credit revolves on utilization. That means as soon as a shipment is done for the credit amount, the credit amount gets reinstated. This type of revolving letter of credit can get trickier if the number of revolvement or the maximum amount is not stipulated in the credit. Because if these limits are not stated the beneficiary may keep on utilizing the credit for an undefined number of times until the LC is expired.

A revolving letter of credit where revolvement is dependent on value also may be either Automatic/Non-automatic or Cumulative/Non-Cumulative. Please refer the below section for details.

Nature of revolvement in Revolving letter of credit

A revolving letter of credit can be of the following types depending on the nature of revolvement:

Automatic revolving letter of credit

An Automatic revolving letter of credit is one in which the revolvement or replenishment of the credit amount happens automatically. No separate amendment is required from the issuing bank to initiate the revolvement. Usually almost all the revolving letters of credit are issued on an automatic basis.

Non-automatic revolving letter of credit

A Non-automatic revolving letter of credit is one in which the issuing bank needs to issue an amendment in order to initiate the revolvement. Until and unless the amendment from the issuing bank is received, revolvement will not happen.

Cumulative revolving letter of credit

In a Cumulative revolving letter of credit, if the amount available for a specific period is not utilized, the amount gets carried forward to the next time period. For example in a cumulative revolving letter of credit where shipment can be done for USD 10000 every month, if in any particular month or months the shipment is not done the amount will be added to the next month.

Let’s understand this with some values. Let’s say the cumulative revolving letter of credit for USD 10000 is valid for 3 months and the amount will revolve every month.

Jan 2023 – USD 10000

Feb 2023 – USD 10000

Mar 2023 – USD 10000

So, in every month from Jan 2023 to Mar 2023, the beneficiary can ship goods for USD 10000.

If the beneficiary doesn’t make a shipment in the month of Jan 2023, the amount for that month will be added to the next month’s amount. So in Feb 2023, he can make a shipment for USD 20000.

Similarly, if the beneficiary does not ship any goods in the first two months, in Mar 2023 he can make a shipment for USD 30000.

Non-cumulative revolving letter of credit

In Non-cumulative revolving letter of credit, if the amount available for a specific period is not utilized, the amount will not be available for utilization in the next time period.

Let’s understand this with the same example we took in the previous section. Let’s say the non-cumulative revolving letter of credit for USD 10000 is valid for 3 months and the amount will revolve every month.

Jan 2023 – USD 10000

Feb 2023 – USD 10000

Mar 2023 – USD 10000

So, in every month from Jan 2023 to Mar 2023, the beneficiary can ship goods for USD 10000.

If the beneficiary doesn’t make a shipment in the month of Jan 2023, the amount for that month will not be available in the next month. So in Feb 2023, he can make a shipment only for USD 10000.

Similarly, if the beneficiary does not ship any goods in the first two months, in Mar 2023 he can make a shipment only for USD 10000. The amounts not utilized in the given timeframe will not be available afterwards.

Advantages of revolving letter of credit

Revolving letters of credit (LCs) offer several advantages for businesses involved in international trade transactions, including:

Increased flexibility: Revolving LCs provide greater flexibility than traditional LCs. With a traditional LC, the beneficiary must apply for a new credit each time they need to make a purchase or shipment. With a revolving LC, the beneficiary can draw down on the credit multiple times, up to a specified limit, without the need to reapply for the credit each time.

Improved cash flow: A revolving LC can help to improve the beneficiary’s cash flow by providing a consistent source of funding for their ongoing business needs. This can be particularly beneficial for businesses that have irregular cash flows or seasonal fluctuations in their business activity.

Cost-effective: Revolving LCs can be a cost-effective financing solution for businesses. By providing a consistent source of funding, the beneficiary may be able to negotiate better terms with their suppliers or reduce their reliance on more expensive forms of financing, such as overdrafts or short-term loans.

Reduced administrative burden: Revolving LCs can reduce the administrative burden for both the beneficiary and the issuing bank. By setting up a revolving LC, the beneficiary can avoid the need to reapply for credit each time they need to make a purchase or shipment, while the issuing bank can streamline their processes and reduce the amount of paperwork they need to process.

Disadvantages of revolving letter of credit

While revolving LC can offer advantages for businesses involved in international trade, there are also some potential disadvantages to consider, including:

Complexity: Revolving LCs can be more complex to set up and manage than traditional LCs. They may require additional documentation and negotiation between the parties involved, which can be time-consuming and costly.

Higher fees: Revolving LCs may come with higher fees compared to traditional LCs. These fees can include both upfront costs and ongoing fees for maintaining the credit.

Risk of over-extension: With a revolving LC, there is a risk that the beneficiary may overextend themselves by drawing down on the credit too frequently or beyond the set limit. This could lead to financial strain or even default on the credit.

Dependence on one bank: Revolving LCs are typically issued by one bank, which means that the beneficiary may become too dependent on that bank for their financing needs. This can limit their ability to access other sources of funding or negotiate better terms.

Suggested Readings