Funding against an incoming letter of credit can be trickier than it ought to be in today's banking environment. A documentary letter of credit (DLC) can only be cashed upon presentation of the required shipping documents and inspection reports (if needed). Before goods ship, the DLC has potential value, but it isn't fungible, or cashable YET. Your supplier wants to be paid in order to produce and ship, but you won't be able to convert that DLC into cash until your supplier ships the product. If you have received a non-transferable letter of credit in payment, you are going to need a bridging mechanism to pay your supplier to get your deal all the way home.
The back to back letter of credit is your bridging mechanism, enabling you to finance your order against the incoming LC. An LC is issued to your supplier, with payment terms that mirror the terms in the incoming LC, same shipping documents, same inspection or other requirements.
There is a second type of businessman for whom the back to back LC is a very useful tool: the broker or middleman who know his industry well enough that he is ready to act as principal. As long as he is still a broker, he always faces the risk that his customers will try and circumvent him. And his earnings are capped by commissions his customers are willing to pay.
When the middleman has enough capital to put up to meet the capital requirements for back to back LC finance, he can leave the brokering rat race.
When he acts as principal, he is no longer has to worry about price transparency or the visibility of buyer to supplier and vice versa.
So What If You Received an LC and Your Supplier Won't Take LC's?
There are industries where the habit of suppliers is not to accept letters of credit. Often this is due to the extremely intense capital requirements of the industry. The scrap metal industry is one such example. Yard owners generally require that they be paid by wire almost the same day as scrap leaves the yard.
In cases like this, a specialized form of bridge financing against incoming LC's is necessary. Fortunately, this, too, can often be done, as there are finance facilities which will allow payment to suppliers if there is an LC in place.
