Back-To-Back Letters Of Credit
Back-to-back letters of credit are two letters of credit (LoCs) used together to finance a transaction. These are used primarily in international transactions. The first letter of credit serves as collateral for the second letter of credit. Back-to-back letters of credit are usually used in a transaction involving an intermediary between the buyer and seller, such as a broker.
Back-to-Back Letter of Credit
Definition
A back-to-back letter of credit (LC) involves using two LCs together to finance a transaction. This is mainly used in international trade. The first LC serves as collateral for the second LC. Back-to-back LCs are typically used in transactions involving intermediaries between the buyer and seller, such as brokers.
Origin
The concept of back-to-back LCs originated in the early 20th century, as international trade rapidly expanded. Merchants needed a reliable way to ensure the security and smooth execution of cross-border transactions. The use of back-to-back LCs became widespread, especially in complex transactions involving multiple countries and intermediaries.
Categories and Characteristics
Back-to-back LCs are mainly divided into two categories: the master LC, issued by the buyer, and the slave LC, issued by the intermediary to the seller. Their characteristics include:
- High security: Ensures the safety of funds through banks acting as intermediaries.
- Flexibility: Suitable for complex international transactions, especially those involving multiple intermediaries.
- Higher cost: Due to the involvement of two LCs, the fees are relatively higher.
Specific Cases
Case 1: A Chinese company (buyer) needs to purchase machinery from Germany but conducts the transaction through a Hong Kong trading company (intermediary). The Chinese company issues a master LC to the Hong Kong company, which then issues a slave LC to the German company. After the German company ships the goods, the Hong Kong company receives and transfers them to the Chinese company, completing the transaction.
Case 2: A US retailer (buyer) needs to procure textiles from India through a UK procurement agent (intermediary). The US retailer issues a master LC to the UK agent, who then issues a slave LC to the Indian supplier. After the Indian supplier ships the goods, the UK agent receives and transfers them to the US retailer, successfully completing the transaction.
Common Questions
1. Are the fees for back-to-back LCs high?
Yes, due to the involvement of two LCs, the fees are relatively higher, typically including bank fees for issuing the LCs and intermediary fees.
2. What types of transactions are suitable for back-to-back LCs?
Back-to-back LCs are suitable for complex international transactions, especially those involving multiple intermediaries, such as brokers or trading companies.
