Revolving Letters of Credit: Key Considerations and Hidden Risks

Revolving letters of credit (RLCs) sound attractive for handling multiple shipments under one instrument. In theory, they save time and paperwork; in practice, they raise complex issues for both banks and traders. Before opening an RLC, it’s worth understanding how they work, the key points to watch out for, and why they are rarely used today.

_______

QUESTION

What are the points one has to keep in mind while opening a revolving LC?

= Bhatia =

_______

ANSWER

Dear Bhatia,

A revolving letter of credit (RLC) is a special type of LC designed to cover multiple shipments under a single instrument, by allowing the credit amount to “revolve” either by time or by value.

When issuing an RLC, the following points should be considered:

1/ Revolving by time or by value

1. • By time: The LC becomes available for a fixed amount at set intervals (e.g., USD 100,000 each month for 12 months).
   • By value: The LC amount is reinstated after each utilization, potentially for an unlimited number of times during its validity.

 2/ Cumulative or non-cumulative

1. • Cumulative: Any unused portion can be carried forward (e.g., USD 5,000 unused this month may be added to next month’s shipment).
   • Non-cumulative: Any unused portion lapses and cannot be carried forward.

3/ Automatic or conditional revolving

Does the LC revolve automatically, or only upon fulfillment of certain conditions (e.g., notice, amendment, or confirmation of shipment)?

4/ Applicant’s credit line sufficiency

The bank will normally block the applicant’s credit line for the maximum potential exposure, not just one installment.

Practical note: In reality, RLCs are rarely used because:

• they tie up a large portion of the applicant’s credit line;
• many banks are not familiar with them; and
• a simpler alternative exists: issue a standard (non-revolving) LC and, once it is fully utilized, amend it to increase the amount, extend the shipment period, expiry date, or other details as needed. This approach has been applied in practice and is often preferred by both applicants and beneficiaries who have long-standing, trusted relationships, since they can jointly decide whether to continue shipments.

Cautionary note: From experience, I have also seen cases where importers and exporters, dealing with each other for the first time, agree to open a large revolving LC because the offered prices are far below market levels. Such arrangements can be a red flag. In several instances, fraudsters posing as sellers were mainly seeking to obtain an RLC in order to misuse it against one or more unsuspecting third parties.

Best regards,

Mr. Old Man