One buyer's credit, one supplier, two ways to pass the payment through: the fees, the blocked cash and the risk the trader carries, priced line by line.
For a trader who sits between a buyer and a supplier, a transferable letter of credit almost always leaves more of the margin than a back-to-back one. On a deal bought at 3,860,000 and sold at 4,200,000, the transfer costs 8,470, against 26,426 for a back-to-back credit, so the trader keeps 331,530 rather than 313,574 of its 340,000 margin. The gap is not the fee schedule: it is the cash margin and the documentary risk that a back-to-back credit puts on the trader's own bank line.
Worked in full in Trade Finance by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The buyer opens a letter of credit for 4,200,000 in favour of the trader, the first beneficiary. The trader has no stock: it will buy the goods from a manufacturer for 3,860,000 and ship them direct. The supplier wants bank security too. There are two ways to give it.
| Input | Value |
|---|---|
| Buyer's credit (master LC), at sight | 4,200,000 |
| Supplier price | 3,860,000 |
| Trader's gross margin | 340,000 (8.1%) |
| Transfer fee, on the amount transferred | 0.20% |
| Substitution and handling, flat | 750 |
| Back-to-back issuance commission, per month, three months minimum | 0.15% |
| Back-to-back issuance and amendment charges, flat | 500 |
| Cash margin demanded on the back-to-back credit | 10% |
| Days the cash margin is blocked | 75 |
| Trader's cost of funds | 8.40% |
| Probability the trader's documents are refused under the master LC | 10% |
| Days to obtain the buyer's waiver | 20 |
Step 1: the transferable route. The transferring bank charges on the amount it passes to the supplier.
Transfer fee = 3,860,000 × 0.20% = 7,720
Total = 7,720 + 750 = 8,470, or 2.5 per cent of the margin
In Excel: =B2*B4+B5
Step 2: the back-to-back commission. The trader's bank prices an issuance like any other credit it opens, at 0.15 per cent a month for a minimum of three months, so 0.45 per cent: 3,860,000 × 0.45% = 17,370, plus 500 of flat charges.
Step 3: the blocked cash. A bank that has to pay the supplier on its own undertaking usually asks for a cash margin unless the trader has a clean line. Ten per cent is 386,000 blocked for 75 days.
Carry = 386,000 × 8.40% × 75 ÷ 360 = 6,755
Step 4: the documentary mismatch. Under a back-to-back credit the trader's bank pays the supplier on compliant documents. If the trader's own presentation under the buyer's credit is then refused, the trader funds the 3,860,000 until the buyer waives the discrepancy: 901 a day, or 18,013 over 20 days. At a 10 per cent chance, the expected cost is 1,801. Under a transfer, a refusal delays the trader's margin but creates no funding gap, because no bank has paid the supplier on the trader's account.
| Cost | Transferable | Back-to-back |
|---|---|---|
| Transfer fee or issuance commission | 7,720 | 17,370 |
| Flat charges | 750 | 500 |
| Carry on the cash margin | 0 | 6,755 |
| Expected cost of refused documents | 0 | 1,801 |
| Total cost | 8,470 | 26,426 |
| Margin kept | 331,530 | 313,574 |
The back-to-back route costs 17,956 more, 5.3 per cent of the margin. Only 9,400 of that is fee difference; the rest is the trader's balance sheet being used.
The two inputs a trader can negotiate are the commission and the cash margin. Each cell shows the back-to-back total cost and, in brackets, how much more it costs than the 8,470 transfer.
| Commission | No cash margin | 10% margin | 25% margin |
|---|---|---|---|
| 0.10% a month (0.30%) | 13,881 (5,411) | 20,636 (12,166) | 30,769 (22,299) |
| 0.15% a month (0.45%) | 19,671 (11,201) | 26,426 (17,956) | 36,559 (28,089) |
| 0.25% a month (0.75%) | 31,251 (22,781) | 38,006 (29,536) | 48,139 (39,669) |
Even on the best terms the back-to-back route is dearer. The case for it is never price. It is used when the buyer's credit is not transferable, when the supplier must be paid against different documents, or when the payment terms differ. That last one is expensive: if the buyer's credit pays at 60 days and the supplier insists on sight, the trader funds 3,860,000 for 60 days, another 54,040 at 8.40 per cent, and keeps 259,534.
Under UCP 600 article 38, a transferred credit must reflect the terms of the original, except that the amount, the unit price, the expiry date, the period for presentation and the latest shipment date may be reduced or curtailed, and the percentage of insurance cover may be increased. The last one is the one traders forget. If the buyer's credit asks for insurance at 110 per cent of the invoice value, it wants cover of 4,620,000. The supplier, insuring at 110 per cent of its own 3,860,000 invoice, would buy cover of 4,246,000, and the documents would be 374,000 short of what the buyer's credit requires.
Insurance percentage on the transferred credit = 4,620,000 ÷ 3,860,000 = 119.7%
In Excel: =B1*1.1/B2
The trader must also substitute its invoice and draft on the first demand. A trader that fails to do so allows the bank to present the supplier's own invoice to the issuing bank, which pays the supplier's price and reveals the margin and the supplier to the buyer.
Ask the buyer for a transferable credit whenever the goods, documents and dates line up, because the bank then carries no exposure to the trader and prices accordingly. Choose a back-to-back credit only for what transfer cannot do, and price the cash margin and the documentary gap in before quoting the buyer. The free workbooks for the book's export case price the credit fees, discrepancies and the cost of money on one order; the fee stack of a single credit is broken down in how letter of credit fees are calculated, and the waiver delay in what a discrepancy actually costs.
A transferable credit is the buyer's own credit, part of which the bank makes available to the trader's supplier; the trader substitutes its invoice and keeps the difference. A back-to-back credit is a second, separate credit that the trader's bank issues to the supplier against the first. In the example the first costs the trader 8,470 and the second 26,426, because the trader's bank takes on a payment undertaking of its own.
Because the master credit is not transferable, because the supplier must be paid on different terms or against different documents, or because the trader wants the buyer and supplier never to see each other's names on the same credit. Each reason has a price: if the master credit pays at 60 days and the supplier wants sight payment, funding the gap costs 54,040 at 8.40 per cent on top.
Enough to give the cover the original credit asks for. If the buyer's credit requires insurance for 110 per cent of a 4,200,000 invoice, that is 4,620,000, which is 119.7 per cent of a 3,860,000 supplier invoice. UCP 600 article 38 allows the percentage to be raised for exactly this reason; leaving it at 110 per cent leaves the cover 374,000 short.
This article is one calculation from Trade Finance. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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