Revocable credit

3 key takeaways

• A revocable credit allows the issuing bank to amend or cancel the credit at any time without prior notice to the beneficiary.
• This type of credit provides less security to the beneficiary, as it can be altered or withdrawn without their consent.
• Revocable credits are less common in international trade due to the higher risk and uncertainty for the beneficiary.

What is a revocable credit?

A revocable credit is a letter of credit issued by a bank that can be modified or revoked at any time before the beneficiary presents the required documents and receives payment.

Unlike irrevocable credits, which cannot be changed or canceled without the agreement of all parties involved, revocable credits offer less assurance to the beneficiary since the terms can be altered, or the credit can be withdrawn without prior notice.

Importance of revocable credit

While revocable credits provide flexibility to the issuing bank and the applicant, they are generally less favored in international trade due to the following reasons:

• Reduced security: Beneficiaries have no guarantee that the credit will remain in force until payment, making it a riskier option.
• Uncertainty: The possibility of sudden changes or cancellations creates uncertainty for beneficiaries, complicating financial planning and operations.
• Limited usage: Due to the higher risk, revocable credits are less commonly used in international trade transactions.

These factors highlight the importance of understanding the implications of revocable credits and their limited use in practice.

Key characteristics of revocable credit

Flexibility for the issuing bank

The issuing bank has the authority to amend or cancel the credit without prior notice to the beneficiary, providing flexibility to adjust terms or withdraw the credit based on changing circumstances.

Risk for the beneficiary

Beneficiaries face higher risk and uncertainty since the credit can be altered or revoked at any time before payment, offering less security compared to irrevocable credits.

Usage in practice

Revocable credits are seldom used in international trade due to the inherent risks and lack of security for the beneficiary. They may be more applicable in domestic transactions or situations where the beneficiary has a high level of trust in the applicant and the issuing bank.

Examples and case studies

Example 1: Revocable credit in a trade transaction

A small exporter in Country A receives a revocable letter of credit from a buyer in Country B. The issuing bank in Country B provides the revocable credit, allowing the buyer to amend or cancel the credit without notifying the exporter.

Despite the potential risk, the exporter agrees due to a longstanding relationship with the buyer. However, before shipment, the buyer cancels the credit due to unexpected financial issues, leaving the exporter without payment assurance.

Example 2: Comparison with irrevocable credit

A large manufacturer receives an irrevocable letter of credit from an international buyer, guaranteeing payment upon presentation of the required documents. This provides the manufacturer with confidence to proceed with production and shipment.

In contrast, had the credit been revocable, the manufacturer would face uncertainty, risking potential non-payment if the buyer or issuing bank decided to cancel the credit.

Case study: Domestic transaction with revocable credit

A domestic supplier agrees to a revocable credit from a trusted local retailer. The issuing bank can modify or cancel the credit if the retailer’s circumstances change. The supplier, confident in the retailer’s reliability, accepts the revocable credit due to their strong business relationship. This arrangement allows flexibility for the retailer while maintaining a level of trust-based security for the supplier.

These examples and case studies illustrate the practical implications and risks associated with revocable credits.

Challenges and considerations

While revocable credits offer flexibility, they also present certain challenges and considerations:

• High risk for beneficiaries: The ability to revoke or amend the credit without notice increases the risk of non-payment, making it less attractive for beneficiaries.
• Limited trust: Beneficiaries must have a high level of trust in the applicant and issuing bank to accept a revocable credit, limiting its practical use.
• Contractual uncertainties: The potential for sudden changes or cancellations complicates contract negotiations and financial planning for beneficiaries.

Addressing these challenges requires careful consideration of the transaction’s context and the relationships between the parties involved.

Strategies for managing revocable credit

To effectively manage revocable credit transactions, consider the following strategies:

• Assess trust and relationships: Evaluate the level of trust and the strength of the relationship with the applicant and issuing bank before accepting a revocable credit.
• Negotiate terms: Where possible, negotiate for an irrevocable credit to ensure greater security and reduce the risk of non-payment.
• Monitor credit terms: Stay vigilant in monitoring the terms of the credit and any communications from the issuing bank to anticipate potential changes or cancellations.
• Diversify payment methods: Consider using multiple payment methods or securing additional guarantees to mitigate the risk associated with revocable credits.

These strategies can help beneficiaries manage the risks and uncertainties associated with revocable credits.

A revocable credit is a type of letter of credit that can be amended or canceled by the issuing bank without prior notice to the beneficiary. While it offers flexibility to the issuing bank and applicant, it presents higher risk and uncertainty for the beneficiary.