What is a back-to-back letter of credit?
A back-to-back letter of credit is a letter of credit (second letter of credit) issued on the basis of an already existing letter of credit (first letter of credit). Generally, the beneficiary on the first letter of credit is the applicant for the second letter of credit. The purpose of structuring the credits in this manner is to secure the payment to be made under the second letter of credit with the payment made under the first letter of credit. However, this structure has not always worked as intended and as a result, banks have experienced many problems with back-to-back letters of credit. Today, back-to-back letters of credit are not offered by many banks and, consequently, are only very rarely used. When available through banks, however, back-to-back letters of credit are used in transactions where the beneficiary on the first letter of credit is a middleman and the beneficiary on the second letter of credit is the middleman’s supplier.
