Letters of credit come in several recognized types, and picking the right one depends on whether you need a payment tool or a backup guarantee, how quickly you want to be paid, whether the deal repeats, and whether an intermediary sits between the buyer and the actual supplier. The main types of letters of credit are commercial (documentary), standby, confirmed and unconfirmed, sight and usance (time), revolving, transferable, back-to-back, red clause, and green clause. Most of these categories overlap rather than compete: a single LC can be, for example, a confirmed sight commercial credit, or an unconfirmed usance revolving one.
Commercial (Documentary) Letters of Credit
The commercial letter of credit, also called a documentary credit, is the workhorse of international trade and the default type most people mean when they say “letter of credit.” It functions as the primary payment mechanism for a shipment. The seller ships the goods, presents the required documents to the bank, and gets paid if those documents match what the LC specifies.1International Trade Administration. Letter of Credit
The document package typically includes a commercial invoice, a bill of lading, a packing list, and a certificate of origin. Depending on the goods, the LC may also call for insurance certificates, quality inspection reports, or health and phytosanitary certificates. Every document must match the LC terms precisely; data across documents doesn’t have to be identical word for word, but nothing can conflict.
Nearly all commercial LCs worldwide operate under the ICC’s Uniform Customs and Practice for Documentary Credits, known as UCP 600, in effect since 2007.2ICC Academy. Documentary Credits Rules Guidelines Terminology Under UCP 600, every LC is irrevocable, is independent of the underlying sales contract, and banks have up to five banking days to decide whether the documents comply.3ICC Academy. UCP 600 and ISP98 – Key Differences and Applications
Standby Letters of Credit
A standby letter of credit is a safety net rather than a payment tool. It sits in the background and is only drawn if the buyer defaults on a contractual obligation. Both parties expect it will never be used. To collect, the seller usually submits a written statement declaring that the buyer failed to perform, along with any supporting documents the LC specifies.
Standbys show up well beyond traditional trade. Construction companies post them as performance guarantees, landlords require them as security deposits on commercial leases, and lenders accept them as collateral. Because the trigger is default rather than shipment, the paperwork is far simpler than a commercial LC: no bills of lading, no packing lists, just evidence that something went wrong.
Standby LCs often operate under a different rule set called ISP98 (International Standby Practices), also published by the ICC. ISP98 allows three-to-seven-day document examination periods, permits renewal of the credit, and generally accepts copies rather than originals.3ICC Academy. UCP 600 and ISP98 – Key Differences and Applications If you’re dealing with a standby, confirm which rule set governs it, because the procedures aren’t interchangeable.
Confirmed vs. Unconfirmed Letters of Credit
Confirmation is a layer added to any LC, not a standalone type. Every letter of credit already carries the issuing bank’s promise to pay. A confirmed LC adds a second bank’s guarantee on top. The confirming bank, usually in the seller’s country, independently commits to honor the LC if the issuing bank doesn’t. This matters when the issuing bank sits in a country with political instability, currency controls, or a banking system the seller doesn’t trust.
Confirmation costs extra. The confirming bank charges a separate fee, roughly 0.25% to 2%, and the riskier it considers the issuing bank or its country, the higher that fee. The buyer and seller negotiate who absorbs the charge, though it often falls on the party requesting confirmation.
An unconfirmed LC is the default. The advising bank passes the LC along and verifies its authenticity but makes no promise to pay. The seller depends on the issuing bank alone. For transactions between established banks in stable economies, unconfirmed usually provides enough security.
Sight vs. Usance (Time) Letters of Credit
Sight and usance describe when payment happens.
Sight Letters of Credit
A sight LC pays the seller as soon as the bank determines the documents comply. “At sight” means payment is due the moment review finishes, which under UCP 600 can take up to five banking days.3ICC Academy. UCP 600 and ISP98 – Key Differences and Applications For sellers who need cash quickly after shipping, this is the fastest turnaround.
Usance (Time) Letters of Credit
A usance LC, also called a time LC, gives the buyer a grace period before payment is due. The LC specifies a future payment date, commonly 30, 60, 90, or 180 days after presentation of documents or after the shipment date. The buyer can receive and sometimes resell the goods before cash leaves the account.
Sellers who don’t want to wait have a way out. A bank can convert the time draft into immediate cash through discounting, paying the seller the face value minus interest and fees. In some cases the bank formally accepts the draft, creating a banker’s acceptance, a negotiable instrument that can trade on secondary markets. Banker’s acceptances tend to involve large denominations and are generally created only by well-known banks.4International Trade Administration. Discounting and Bankers Acceptance
Revolving Letters of Credit
When a buyer and seller trade regularly, opening a fresh LC for every shipment is expensive and tedious. A revolving LC reinstates the credit amount automatically after each draw, either up to a set number of uses or within a defined period. A buyer shipping $50,000 in goods each month can open one revolving LC for $50,000 that resets monthly, instead of applying for twelve separate credits over a year.
The cumulative-versus-non-cumulative distinction matters for cash flow. A cumulative revolving LC rolls unused balance forward. Draw only $30,000 of a $50,000 monthly limit and next month’s ceiling becomes $70,000. A non-cumulative revolving LC does not carry forward. Draw nothing in February and March’s limit stays at $50,000, with the February allocation gone.
Transferable and Back-to-Back Letters of Credit
Two types exist for middlemen who source goods from producers but don’t manufacture anything themselves.
Transferable Letters of Credit
A transferable LC lets the original beneficiary redirect all or part of the credit to another party, typically the actual manufacturer or supplier. The middleman uses the LC to assure their supplier of payment without revealing the end buyer’s identity or the full sale price.5ICC Academy. Transferable vs Back-to-Back Letters of Credit
An LC is transferable only if it expressly says so, and the buyer has to agree to that feature at issuance. Under UCP 600, the credit can be transferred to second beneficiaries, but those second beneficiaries cannot transfer it again. The middleman can split the credit among multiple suppliers, but the chain stops at one transfer.
Back-to-Back Letters of Credit
When a transferable LC isn’t available or practical, intermediaries sometimes use back-to-back LCs. This involves two entirely separate credits. The buyer’s bank issues the first (master) LC in favor of the intermediary. The intermediary then uses that master LC as collateral to have their own bank issue a second LC in favor of the actual supplier.5ICC Academy. Transferable vs Back-to-Back Letters of Credit
Back-to-back arrangements carry more risk for the intermediary’s bank because the two credits are legally independent. If documents under the second LC don’t perfectly match what the first LC requires, the intermediary can end up paying the supplier but not being paid by the buyer’s bank. Banks are sometimes reluctant to issue back-to-back credits for this reason, and the intermediary usually needs a strong credit relationship with their bank to arrange one.
Red Clause and Green Clause Letters of Credit
These two types build pre-shipment financing into the LC itself.
Red Clause Letters of Credit
A red clause LC lets the seller draw an advance from the bank before shipping anything, covering pre-shipment costs like raw materials, labor, or production expenses. Once the seller ships and presents compliant documents, the bank deducts the advance plus interest and fees from the final payment.1International Trade Administration. Letter of Credit
The advance is essentially an unsecured loan from the buyer to the seller, channeled through the bank. If the seller takes the advance and never ships, the buyer bears the loss. The name comes from the old practice of typing the advance provision in red ink to flag it.
Green Clause Letters of Credit
A green clause LC works like a red clause but adds a layer of security. The seller can still draw pre-shipment advances, but must provide evidence that the goods exist and are being stored, typically warehouse receipts, before the bank releases funds. Storage and insurance costs during the warehousing period are also covered under the advance. The buyer’s protection is that the goods are at least produced and warehoused, even if not yet shipped.
Picking the Right Type
Most decisions come down to a few practical questions. If you need a payment mechanism tied to a shipment, you want a commercial LC. If you want a guarantee that only pays out if something goes wrong, you want a standby. If you don’t trust the issuing bank or the country it operates in, add confirmation. If you’re the seller and want cash immediately, ask for a sight LC; if you’re the buyer and want time to resell before paying, propose a usance LC. Repeat business points to a revolving structure. Middlemen who don’t manufacture goods themselves look at transferable or back-to-back arrangements. Sellers who need working capital before they can ship look at red or green clause credits.
Fees vary by type. Issuance runs roughly 0.1% to 1% of the LC value, and specialized types like revolving or transferable credits cost more than a standard commercial LC because of their added complexity. Confirmation, amendments, advising, and document handling all carry separate charges. Buyers usually cover issuance and advising on their side while sellers absorb negotiation and document charges on theirs, though who pays what is negotiable.