Red Clause Letter of Credit

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A red clause letter of credit is a financial instrument that has been in use for a long time. It is a type of letter of credit that is used to provide financial assistance to the seller before the goods are delivered.

Red clause letter of credit

What is a Red Clause Letter of Credit?

A red clause letter of credit is a type of letter of credit that includes a clause that allows the beneficiary to receive an advance payment from the issuing bank. This type of LC is also known as Advance payment documentary credit.

Such letters of credit typically include a provision that allows the recipient to obtain a pre-shipment advance up to the amount specified in the LC. This clause was traditionally printed in red ink which gave rise to the term “Red Clause LC.” The nominated bank, acting on behalf of the issuing bank, provides the pre-shipment credit to the recipient in accordance with the authority granted by the issuing bank.

The red clause letter of credit is different from a regular letter of credit because it allows the seller to receive an advance payment before the goods are delivered. This can be useful for the seller because it provides them with the financial assistance they need to purchase raw materials and to prepare and ship the goods.

Red clause letter of credit risks

While Red Clause Letters of Credit (LC) can provide an advantage to the beneficiary by allowing them to obtain pre-shipment finance, there are also some risks involved. These risks may include:

Risk to the issuing bank: The issuing bank bears the risk of the beneficiary’s default on the advance payment. If the beneficiary fails to repay the advance, the issuing bank may have to bear the loss.

Risk to the nominated bank: The nominated bank providing the pre-shipment credit also bears a risk if the beneficiary fails to repay the advance, as they are liable to reimburse the amount paid by the issuing bank.

Risk to the beneficiary: If the beneficiary is unable to export the goods as specified in the LC, they may be liable to repay the advance to the nominated bank or the issuing bank, which can result in financial difficulties.

Risk of fraud: There is always a risk of fraud associated with any financial instrument, including red clause LCs. This can occur through forged documents, fictitious shipments, or other fraudulent activities.

Therefore, it is important for all parties involved in a Red Clause LC transaction to be aware of the potential risks and to take appropriate measures to mitigate them. This may include thorough due diligence, careful examination of all documents, and working with reputable banks and partners.

Green clause letter of credit

A Green Clause Letter of Credit (LC) is a type of LC that allows for the beneficiary to receive advance for warehousing and insurance charges in addition to preparation and shipment of goods. The green clause LC is named so because the text of the clause was traditionally printed in green ink, as opposed to the red ink used for the clause in a Red Clause LC.

The Green Clause LC allows the beneficiary to receive an advance payment from the nominated bank to finance the purchase, collection, and preparation of goods for shipment. The beneficiary can also use the funds to store and insure the goods until they are ready for export. This can be particularly useful for commodities that require processing or that have a long lead time before shipment.

Difference between red clause and green clause letter of credit

Red Clause and Green Clause Letters of Credit (LCs) are two types of LCs that offer pre-shipment financing to the beneficiary. While they have some similarities, there are also key differences between the two:

Purpose: The main difference between the two is the purpose of the financing. Red Clause LCs provide financing for the purchase of goods and the cost of shipment, whereas Green Clause LCs provide financing for the purchase,  processing of goods as well as for storage and insurance of goods.

Funds: Red Clause LCs provide a limited amount of pre-shipment finance, whereas Green Clause LCs allow for a more extensive range of pre-shipment financing as well as post-shipment financing.

Clause colour: Red Clause LCs get their name from the red colour ink used to print the clause allowing for pre-shipment financing, while Green Clause LCs get their name from the green colour ink used to print the clause allowing for pre-shipment and post-shipment financing.

Processing time: The processing time for Green Clause LCs is typically longer than for Red Clause LCs due to the additional financing requirements.

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