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LC SPECIALIST VS. LC SPECIALIST
OVER
BACK-TO-BACK LC VS. TRANSFERABLE LC
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Editor's note: The banker may not sell what the
exporter wants; the exporter may not be
ready to buy what the banker wants to sell. For example, the banker may be
reluctant to issue a back-to-back LC when the exporter asks for it and
instead may advise him to use a transferable LC; but the exporter may be
reluctant to use transferable LC. Either side sees its own interest. The
LC specialists here debate the reluctance issue.
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JIA HAO
Bank of China
China
Contributing Editor of
LC VIEWS
The banker's
reluctance to issue a back-to-back LC may be due to the exporter's
reluctance to meet the banker's lending requirements rather than due
to the risky nature of the back-to-back type of LC.
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The
bank that issues back-to-back L/C undertakes a definite payment obligation
under L/C law and practice, while the bank that transfers a transferable L/C
does not obligate to pay. Instead, the transferring bank usually pays after
receipt of issuing bank's payment under the transferable credit. That is the
biggest difference between the two things. Given such difference, an
exporter/beneficiary should maintain adequate credit line or L/C margin
funds for applying for the issuance of the back-to-back L/C as the bank
seldom relies on the proceeds available under the master L/C to issue a
back-to-back L/C, while in case of transferable L/C it needs no credit line
or funds for arranging the transfer of L/C provided that the L/C is
stipulated itself as transferable, In this connection, it cannot be said
that a bank feels reluctant to handle back-to-back L/C, because it may feel
uncomfortable to issue back-to-back L/C mainly depending upon the security
provided by the exporter/beneficiary. Instead, it may be said that the exporter/beneficiary
may feel more difficult to obtain a back-to-back L/C rather than transfer of
a L/C. Moreover, given the high risks concomitant with high profits, the
bank may feel happy to issue a back-to-back L/C for more handling charges
with a proper risk control that includes the evaluation of the exporter/beneficiary's
financial standing, reimbursement ability and the like as well as the
adequacy of security available from the exporter/beneficiary. And one thing
more should be done by the bank is to examine the terms and conditions of
the L/C and evaluate the creditworthiness of the issuing bank under the
master L/C. In a nutshell, the bank that arranges for a back-to-back L/C
should do what it should do as an issuing bank, while the transferring bank
may be deemed as a special advising bank (advise a transferred credit which
is different from the transferable credit received) and a collecting bank (distribute
the proceeds received from the issuing bank to the first and second
beneficiary).
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Kim Christensen
Trade Finance Specialist
Nordea,
Denmark
Associate Editor,
LC
VIEWS
The reluctance is not
universal. The reluctance may be based on a bank's risk evaluation policy.
A back-to-back LC if well constructed can mitigate the risks
associated with such kind of LC.
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First of
all one should recognize that - unlike a transferred LC - a back-to-back
LC is a separate LC based on another LC. Secondly the (typical)
transaction where the back-to-back LC is "in play" is where there is a "middleman"
- who is not the end-user and not the producer of the goods.
This
so-called reluctance is probably geographical - where in some parts of the
world you see none - while in other areas you will see them every day.
There may
be many reasons for this reluctance - from my experience it is mainly
based on the risk evaluation/policy by the bank. Since the back-to-back LC
is a separate LC the risk evaluation by the bank issuing the back-to-back
LC would be similar to that of a "normal" LC. In many cases this will
constitute a problem for the middleman - cost wise - as well as in terms
of if the bank is actually willing to issue the LC. This is most likely
the main difference between the back-to-back and the transferable credit.
The transferring bank is not an issuing bank - and will consider handling
risk alone when transferring the LC.
Having said
this, I would argue that a well constructed back-to-back LC would - to a
large extent - migrate the risk for the 2nd issuing bank - and the
handling risk would be similar to that of the a transferable LC.
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on Back-to-Back vs. Transferable LC |
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UBS AG
writes in its publication
"Documentary Credits, Documentary Collections, Bank Guarantees": In view of the
fact that back-to-back credit transactions are exposed to risks far above
the average, preference wherever possible
should definitely be given to a transferable credit.
However, UBS is prepared to issue a
back-to-back credit only if the middle man or general contractor is
considered sufficiently reliable and capable
of a faultless execution of his part of the operation.
Nevertheless, according to the
degree of risk and amount of work involved, the commissions for
back-to-back credits may be increased over
those for "normal" credits.
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REINHARD
LANERICH
IN SEARCH OF REASONS FOR USING
BACK-To-BACK LC
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Writing in his book "Documentary Credits in Practice" Reinhard Langerich says:
There may be different reasons for using a
back-to-back credit. The applicant may not want his credit to be
transferable because thereby he could lose some of the control and
security inherent in the credit. The beneficiary may also refrain from
requesting a transferable credit because he does not want to leave the
impression with the applicant that he needs this security to get the goods.
A third reason could be the beneficiary's need to make alterations in a
credit to be issued favor of a sub-supplier.
Talking of the risks for the banker in
issuance of a back-to-back LC, he says "some of ... risk elements may be
diminished by ensuring appropriate issuance of the credit in favor of the
sub-supplier.
Editor'note: Reinhard Langerich discusses in the said
book the tips for issuing an appropriate back-to-back LC . The book is
available free of cost from "Library" on
www.lcviews.com.
You must keep this book in your business briefcase. Kim Christensen -
Reinhard Langerich is his Guru - has also said (see his comments in the
debate on this web page) that a back -to-back credit must be well
structured. Reinhard Langerich aptly explains do's for structuring a
back-to-back credit in his said book, which you now must download from
our online "Library". For technical help in downloading, contact
Kim Christensen.
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MANY BANKS DRAW
COMFORT FROM SAYING NO TO BACK-TO-BACK TRANSACTIONS
R.S.
Rangan, Head of Trade Sevices, National Bank
of Fujairah. U.A.E.
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Under normal circumstances back to back LCs are issued for those who may not
have independent credit facilities for issuance of LCs or those who may not
want their credit facilities being used for such specific transactions. The
issuing Bank therefore considers the incoming LC as a comfort whilst issuing
their LCs.
Since the issuing bank thus takes full credit risk on the transaction, in a
situation of non-payment of the slave LC, it is possible that the
“applicant” (beneficiary of the original LC) may not participate/assist them
in sorting out the issues under the master LC. Also in back to back LC
transaction the “comfort” which the issuing bank would derive by having
title to goods may be missing or inadequate
Due to these reasons many banks have a policy of not entering into any such
back to back transactions.
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Get it Right The First
Time
Jee Meng CHEN, operational risk executive
To generalize what I have seen so far, the
Middleman's Bank usually "avoids" issuance of the Backing L/C or (baby)
credit for reasons, namely, (i) perceived [heightened] lending risk / credit
risk exposure and/or (ii) Operational risks. Operational risks cover a broad
spectrum of operational considerations including technical issues, for
example, switching of Bills of Lading.
A transaction can be structured on a "back-to-back"
basis, involving (i) L/Cs or (ii) without issuance of the Backing L/C.
Structured trade transactions, which apply back-to-back L/Cs, are fairly
common among banks that engage in structured trade financing and/or
structured commodity financing. The classic case would involve a middleman
or trader, who has the requisite marketing contacts but lacking in the
financials. This is what we commonly referred to as "Thin Balance Sheet".
A word of caution, however.
Get It Right The First Time.
While technical competency in trade financing
operations, for instance, familiarity with requisite documentation, control
issues, etc., is integral to the success of back-to-back L/C operations, (i)
Due Diligence [i.e. Know Your Customer and Counterparties] and (ii) a robust
Credit Structure assumes greater importance. In the absence of a robust
structure and/or feasible structure, the proposed transaction is likely to
fail.
Knowledge of back-to-back L/C operations must go
hand-in-hand with the underlying credit proposition. The back-to-back L/C is
such an interesting topic that one can write pages after pages...
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