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Revolving credits
There is hardly any type of documentary credit that is more inexact than the revolving credit.
The expression itself hardly tells you anything. It is necessary that the documentary credit itself evidence a precise description of the "revolving function."
The purpose of a revolving credit is to avoid the issuance of a number of identical documentary credits; e.g. with the same:
- Parties
- Type of goods
- Documentation
Whereby the documentary credit will "revolve" automatically.
A revolving credit may be:
1. Automatic
2. Non-automatic
3. Cumulative
4. Non-cumulative
Automatic versus non-automatic
In case of an automatically revolving credit, no further amendments are required when the amount once again falls due or becomes available.
In case of a non-automatic revolving credit, the issuing bank must amend the credit each time a revolvement is due.
Cumulative versus non-cumulative
"Cumulative" means, that any undrawn balance in one revolvement is carried forward to the next.
In a non-cumulative revolving credit, the outstanding balance is not carried over, i.e. any balance not been drawn is lost.
This means that the revolving credit must indicate whether or not it is automatic or non-automatic and cumulative or non-cumulative.
In addition the revolving credit should include the number of times the credit can revolve as well at the time limits for the drawings.
The beneficiary is likely to prefer a cumulative, automatic revolving credit as they have a bank undertaking for the full amount of the value of their goods.
The issuing bank (and a confirming bank for that matter), must book the full liability for the maximum amount that could be drawn under the revolving credit.
This means that the limit of the applicant will be booked for the full amount, already when the revolving credit is issued.
For that reason the parties often choose to use a standby letter of credit - covering the buyers payment obligation instead of a revolving credit.
That way the actual payments are made "outside" the standby letter of credit, and the standby letter of credit is only used (by the seller) in case of non-payment. That way the amount of the standby letter of credit should only cover the maximum outstanding amount at any time.