When Two LCs depends on Each Other – The Story of Reciprocal Credits

These days, you’d be hard pressed to find a reciprocal LC in the market—they’ve more or less vanished with time. But that doesn’t mean the topic is useless. For processors who still have to import raw materials and then ship out finished products, understanding how reciprocal LCs once worked can still serve as a valuable reference point.

 QUESTION

Dear Mr. Old Man,

We are studying international payments and need to research reciprocal letters of credit. However, materials on this type of LC are very limited (since it is no longer widely used). Although we have already read on your blog about the basic features of this LC, we would like to learn more in-depth. We hope you can help us!

Here are some questions we would like your guidance on:

Q1: How is the presentation of documents under a reciprocal LC carried out?

Q2: Nowadays, Vietnamese subcontracting companies often use the collection method instead of reciprocal LCs. What advantages does the collection method have compared to reciprocal LCs?

Q3: The application of reciprocal LCs is often disadvantageous for the party outsourcing the processing in export processing transactions. Could you suggest some measures to overcome this situation?

Q4: What are some advantages and disadvantages of this type of LC?

Thank you for your clarification.

Sincerely,

DS

______

ANSWER

Dear DS,

I’ve never been a fan of purely theoretical questions where students try to tick every box for their professors. Real-life trade finance is often far messier—and more practical—than what’s found in textbooks.

That said, since you’ve asked about reciprocal LCs, let me recap the basics first before addressing your specific questions.

What is a Reciprocal LC?

A reciprocal LC was mainly used in export processing arrangements, where both parties acted as importer and exporter. Such an LC is issued—or takes effect—only when another LC is opened in return.

Unlike ordinary LCs, which are payable once complying documents are presented, a reciprocal LC is conditional: the issuing bank undertakes to pay only after it has received funds under the counter LC.

A typical clause would look like this:

“This LC is reciprocal to LC No. … dated … issued by … Bank. Upon receipt of complying documents, we (the issuing bank) shall accept the draft/documents and effect payment only after receiving full proceeds under LC No. … dated … issued by … Bank.”

Example:

Shingbang Ltd. (Korea) contracts with Garment Company No. 5 (Vietnam) to process garments. Shingbang opens a master LC (for finished goods) in favor of Garment Co. No. 5. In turn, Garment Co. No. 5 opens a 90-day deferred LC (for raw materials) in favor of Shingbang.

When Garment Co. No. 5 receives LC No. 123 dated 20/09/20xx issued by Korea Bank, it asks its bank (Vietnam Bank) to issue a reciprocal 90-day deferred LC in favor of Shingbang.

The reciprocal LC might read:

“This LC is reciprocal to LC No. 123 dated 20/09/20xx issued by Korea Bank. Upon receipt of complying documents, we shall incur a deferred payment undertaking, but actual payment will only be made after we receive full proceeds under LC No. 123 dated 20/09/20xx.”

This arrangement was once common in parts of Asia. In Vietnam, reciprocal LCs were frequently used in the 1990s when garment companies processed for Korean buyers. Today, they are rarely seen.

Q1. How is document presentation under a reciprocal LC carried out?

Document presentation works the same way as under a normal LC: the beneficiary must provide exactly what the LC calls for. The difference lies not in presentation, but in the payment condition.

• For raw material import LCs, typical documents include:
  • Draft at xxx days sight
  • Invoice
  • Bill of Lading
  • Packing List
  • Certificate of Origin
  • …

The beneficiary (the outsourcing party) presents documents through its bank to the bank of the processor.

• For finished goods import LCs, typical documents include:
  • Draft at sight
  • Invoice
  • Bill of Lading
  • Packing List
  • Certificate of Origin
  • Inspection Certificate
  • …

The beneficiary (the processor) presents documents through its bank to the bank of the outsourcing party.

Q2. What advantages does the collection method have over reciprocal LCs?

Why use reciprocal LCs in the past? In short—lack of trust. Vietnamese subcontractors learned some hard lessons when foreign partners, after being paid for raw materials, vanished without taking delivery of finished goods.

If both sides trust each other and want long-term cooperation, any method—including collections—can work.

Compared with reciprocal LCs, documentary collections are:

• Simpler in procedure
• Cheaper in banking fees
• Faster to process

Q3. How can the disadvantages for the outsourcing party be addressed?

Under a typical structure, the outsourcing party risks not being paid even if drafts are accepted—because the issuing bank for raw material imports pays only after receiving funds from the finished goods LC.

Possible solutions:

• Negotiate better terms. For example, the issuing bank could undertake:

“This LC is reciprocal to LC No. 123 dated … issued by ABC Bank. Upon receipt of complying draft(s) and documents, we shall accept the draft(s) and pay them upon receipt of proceeds under LC No. 123. However, if the beneficiary of LC No. 123 fails to present documents by the maturity date of the accepted draft(s), we shall effect payment on the 3rd banking day after maturity.”

Such wording is fairer for both sides.

• Do proper KYC. Know your customer—who they are, how reliable they are, and whether they can perform. With trust established, the parties might move to open account terms, or even offset payments so that only net differences are settled.

Q4. Advantages and disadvantages of reciprocal LCs

Advantages

• With balanced wording, reciprocal LCs can ensure “fair play” between the two sides.
• Useful where partners do not yet know or trust each other.

Disadvantages

• Complex structure and cumbersome procedures
• Higher banking costs

Conclusion

The discussion above goes beyond your four questions, but that’s intentional—it provides background and context for other readers who may be curious about this now-rare LC type. Some of the details may feel advanced for students, but they reflect how things really worked in practice.

Best regards,

Mr. Old Man