Back-to-Back Letters of Credit Definition
A back-to-back letter of credit is a financial instrument often used in international trade, where a seller in a transaction requires the buyer to have a letter of credit from a bank. It is considered a new, distinct letter of credit that is derived from the original letter of credit issued by the buyer.
Back-to-Back Letters of Credit Key Points
- A back-to-back letter of credit is designed to secure payment for suppliers of goods in international transactions.
- This instrument is typically used when the intermediary does not have the financial resources or creditworthiness to secure a traditional letter of credit.
- The original letter of credit serves as collateral for the issuance of the second one.
- This instrument involves two different letters of credit and two different beneficiaries.
What is a Back-to-Back Letters of Credit?
Back-to-back letters of credit involve three parties: the buyer, the intermediary, and the supplier. The buyer acquires a letter of credit from its bank and sends it to the intermediary’s bank. The intermediary then uses this as collateral to obtain a second, distinct letter of credit, which is then forwarded on to the supplier. It’s typically used when the intermediary doesn’t have the money or creditworthiness to secure a traditional letter of credit.
Why is a Back-to-Back Letters of Credit important?
This financial instrument is important because it allows for secure and guaranteed payments in international trade transactions. It gives the supplier assurance of payment, and it gives the intermediary access to trade financing that might not be otherwise available. In essence, the intermediary is leveraging the creditworthiness of the buyer.
Who uses a Back-to-Back Letters of Credit?
Back-to-back letters of credit are typically used by intermediaries in international trade transactions. These intermediaries are often traders or brokers who are facilitating the sale of goods from a supplier to an end buyer. The intermediary may not have the funds or credit necessary to obtain a traditional letter of credit, which is where the back-to-back method comes into play.
When is a Back-to-Back Letters of Credit used?
This financial instrument is used in complex international trade transactions, particularly when the intermediary, such as a trader or a broker, lacks the funds or creditworthiness to obtain a traditional letter of credit.
How does a Back-to-Back Letters of Credit work?
The process begins when the intermediary brokers a deal between the end buyer and the supplier. The buyer obtains a letter of credit from their bank and forwards it to the intermediary. The intermediary then uses this original letter of credit as a form of collateral to obtain a second, separate letter of credit from their bank. This second letter of credit is then sent to the supplier. Once the supplier meets the terms and conditions of the letter of credit (such as supplying the goods), the supplier gets paid.
