What is Back To Back Letter Of Credit?
A back to back letter of credit is made of two letters of credit (LCs) used together to finance a business transaction. The two LCs are opened in favor of the customer with some terms and conditions used as security for repayment. Back to the back letter is often employed in a transaction that involves an intermediary between a buyer and a seller. A good example of such an intermediary is a broker. The letter can also be used when a seller is required to buy the goods it will sell from a particular supplier as part of the sale to his or her buyer.
Understanding Back To Back Letter Of Credit
As already stated, a back to back letter of credit is made up of two letters of credit.
Letter of credit issued by the bank of the buyer to the intermediary on behalf of the buyer.
Letter of credit issued by the bank of the intermediary on behalf of the seller.
After acquiring a letter of credit from the bank of the buyer, the broker proceeds to his own bank and gets a second letter of credit using the seller as the beneficiary. With this, the seller is assured of his or her payment upon fulfilling the terms of the contract and presenting the intermediary bank with the necessary documents. In most cases, the seller only communicated with the intermediary and might not know who the real buyer of the goods is.
Back to back letters of credit are usually used in an international transaction with the first letter of credit acting as collateral for the second letter during a transaction. The two letters of credit( the buyer and the intermediary ) are necessary to facilitate trade between the two main parties, the buyer and the seller.
Example Of Back-to-back Letter Of Credit
Take for instance company A is located in the US and sells jewelry including ones made with pure gold and diamonds. Company B, a big fashion trading firm located in China heard that company C which is in Germany needs some authentic jewelry and has been able to broker a deal between the two companies. Company A wants to sell but is skeptical of default of payment from company C. Company B wants this transaction between the two companies to go smoothly.
A back-to-back letter of credit can be used to ensure that the transaction goes well. What company C would do is to acquire a letter of credit from a very popular financial firm in Germany using company B as the beneficiary. After this, company B would use the letter of credit sent by company C to acquire another letter of credit from his own bank in China and send this to the company in the US.
Upon receiving the letter of credit from company B, company A can now sell to company C believing that after the transaction, it would get its money through company B.