What is the compensation credit’
Back to back letters of credit consist of two letters of credit (letters of credit) used to Finance the transaction. The compensation credit is usually used in transactions involving an intermediary between the buyer and the seller, such as a broker, or when the seller must get the goods he will sell from the Vendor as part of the sale to the buyer.
Penetration ‘compensation letters of credit’
“Back to back” letters of credit actually consists of two separate letters of credit issued by the buyer’s Bank to the intermediary and the other issued by the Bank to the middleman to the seller. With the original LC from the buyer’s Bank in place, a broker, go to your Bank and has a second LC issued, with seller as beneficiary. Thus, the seller is guaranteed Payment after the conditions of the contract and presenting the appropriate documents to the Bank mediator. In some cases, the seller may not even know who the final buyer of the goods.
As is often the case with LCS, back to back LCS are used primarily in international operations, with the first LC serving as collateral for the second. “Back to back” LCS is essentially a substitute for two credit-issuing banks for the buyer and the mediator and thus facilitate trade between the parties, which can deal with large distances and who may not otherwise be able to check each other’s credit.
An example of a back-to-back LC transaction
For example, assume that the company is in the USA and sells heavy equipment. Broker B trading company, based in London, it became known that the company C which is located in China, wants to buy heavy equipment and managed to cut a deal between the two companies. Company a wants to sell but don’t want to take the risk of non-payment by company C. the broker B wants to make sure that trade is made, and that he gets his Commission.
Back to back LCS can be used to ensure that the transaction will take place. Company C will go to a well-known financial institution in China and force it to issue the LC to the broker and the beneficiary. In turn, broker B will use the LC to go to their own well-known financial institution in Germany and it will give LC a company
The company now can ship it heavy, knowing that after the deal is completed, it will be paid by the German Bank. The broker also assured of being paid. Credit risk was excluded from the agreement.