THE FIRST QUESTION · THE ECONOMY · CURRENCY AND TRADE
An exporter sells a commodity priced in US dollars and pays its costs in its home currency. The home currency has strengthened 20% against the dollar.
// WORKED EXAMPLEWHERE THE RISK SITS
Back-to-Back Letter of Credit: Why Banks Are Wary
Two credits that must match, and a bank that pays if they don't.
BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED
// THE SHORT ANSWER
To the bank asked to issue it, a back-to-back letter of credit is a request to lend to a trader against a credit another bank has issued. The trader holds a master credit from its buyer's bank and asks its own bank to open a second, separate credit to its supplier, on similar terms for a lower amount. That bank must pay the supplier against complying documents whatever happens under the master, so it relies on the trader turning the supplier's documents into a complying presentation in time. When that fails, the bank is left with a claim on the trader.
BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.
// MAKE THE CALL
Issue 02 — Aoraki Trade Exports. Paid in USD, costs in NZD, asking for a NZ$6m multi-currency facility. The MD won't say which currencies. Your call first, then the senior banker's.
// 01 — WHAT THE TRADER IS ASKING FOR
A trader that buys from one party and sells to another often has neither the cash nor the limits to pay its supplier before its buyer pays it. If the buyer has opened a letter of credit in the trader's favour, the trader can ask its own bank to use that credit as the basis for a second one in favour of the supplier. The supplier sees a bank's promise, the buyer sees nothing different, and the trader keeps its supplier's identity and its margin to itself.
The weakness lies in the word basis. The two credits are separate undertakings, usually by different banks. UCP 600, the ICC's rules for documentary credits, has no article on back-to-back credits: each is an ordinary credit, separate from the sale contracts behind it and from the other credit. The second bank's promise to the supplier does not depend on the trader being paid under the first.
// 02 — HOW THE TWO CREDITS ARE MATCHED
The second credit is drafted from the first, so that the supplier's documents, with the trader's own invoice and draft put in place of the supplier's, will comply with the master. The usual adjustments run one way: wherever the trader needs room to work, the second credit is tighter.
Master credit Second credit
Amount trader's sale price supplier's price, lower
Latest shipment as the sale contract same or earlier
Presentation period e.g. 21 days after shorter, to leave time
shipment
Expiry date X before date X
Documents as the buyer requires the same, worded to
comply with the master
The documents are the hard part. The bill of lading, certificate of origin, inspection certificate and packing list come from the supplier's side, and each must satisfy the master credit when the trader presents them. Wording that differs by a port, a description of the goods or a consignee can make the supplier's documents comply with the second credit and fail the first. Banks therefore commonly require the second credit to mirror the master closely, and want the trader to present under the master through them.
// 03 — THE EXAMPLE
A packaging trader, constructed for this page like every figure in it, sells food-grade containers to an importer for US$2.0m under a master credit from the importer's bank, and buys them from a manufacturer for US$1.7m. Its own bank, nominated under the master, issues a back-to-back credit to the manufacturer for US$1.7m, expiring ten days before the master, with a presentation period of ten days against the master's twenty-one.
Master credit, the trader's sale 2,000,000
Second credit, the trader's purchase − 1,700,000
Trader's margin 300,000
Supplier must present within 10 days of shipment
Trader must present within 21 days of shipment
Left for substitution and checking 11 days
The second credit was drafted to allow shipment from any port in the manufacturer's country; the master names one port. The manufacturer ships from another. Its documents comply with the second credit, and the trader's bank must pay it US$1.7m. Presented under the master, the same bill of lading shows the wrong port of loading. The importer's bank refuses. The importer, whose own selling price has fallen, declines to waive the discrepancy. The trader cannot repay its bank. The bank gets the documents back. If the bills are made out to order and endorsed in blank, they give it control of goods it did not want in a port it did not choose; if the master required them consigned to the order of the importer's bank, they give it less. Either way it holds a claim on a trader without the cash to meet it.
Nothing in the example is exotic. One loose line in a credit drafted under time pressure moved US$1.7m of risk from the importer's bank to the trader's.
// 04 — HOW IT DIFFERS FROM A TRANSFERABLE CREDIT
A transferable letter of credit reaches the same end with one credit. The buyer's bank marks it transferable, a bank transfers part of it to the supplier on tightened terms, and the trader substitutes its own invoice and draws the difference. No second undertaking is created, so the transferring bank takes no credit risk on the trader unless it also finances it; if it has confirmed the credit, its added risk is on the issuing bank. The price is that the buyer must agree, which tells it a supplier stands behind the trader, and a transferred credit cannot be transferred again.
That is why many banks prefer a transfer where the buyer will agree, and offer back-to-back credits mainly to traders they would lend to anyway, within a limit sized as for an unsecured advance. Some also take cash cover for part of the second credit, or ask that the master be issued or confirmed by a bank they accept.
DEFINED IN ONE PARAGRAPH → · TRANSFERABLE CREDITS → · CONFIRMED CREDITS →
// 05 — WHERE IT DECIDES A FILE
The credit decision is about the trader, not the transaction. The master credit lowers the risk only if three things hold: the master's issuing bank is good for the money, the trader's bank is placed to receive the supplier's documents and present them under the master, and the trader's staff can substitute and present within the gap. A credit paper that calls the back-to-back secured by the master has missed that the master pays only for documents the trader has not yet produced.
The safeguards are in the drafting and in the record. The two credits are compared term by term before the second is issued, and every later amendment to either is checked against the other, because an amendment to the master that the second credit does not follow reopens the gap. A trader's history of clean presentations under earlier credits is evidence a lender can read; a history of waived discrepancies is a warning.
HOW BANKS READ EXPORTERS → · BANK GUARANTEE VS LETTER OF CREDIT →
// SOURCES
The documents the statements on this page rest on. Each was opened and checked when cited.
- International Chamber of Commerce, Uniform Customs and Practice for Documentary Credits, UCP 600 (2007 revision) — articles 4, 14(c) and 38 — Makes each credit a transaction separate from the underlying contract, sets the default 21-day presentation period for original transport documents, and governs transferable credits in article 38, with no corresponding article for back-to-back credits — sections 01, 02 and 04.
// QUESTIONS PEOPLE ASK
- What is the difference between a back-to-back and a transferable letter of credit?
- A transferable credit is a single credit made available in part to the supplier by a bank's transfer, on tightened terms. No new undertaking is created, and the trader substitutes its own invoice to take its margin. A back-to-back arrangement is two credits: the master from the buyer's bank to the trader, and a new one from the trader's bank to the supplier. The second bank is bound to pay the supplier on its own credit, so it carries a risk on the trader that a transferring bank does not.
- Is a back-to-back letter of credit secured by the master credit?
- Only loosely. The trader's bank may be nominated under the master and receive the documents to present under it, but the master pays only against a complying presentation the trader has yet to make. If the supplier's documents comply with the second credit but not the master, the bank must still pay the supplier and may collect nothing under the master. Banks therefore assess the trader's own creditworthiness and treat the second credit as an exposure to it.
- Does UCP 600 cover back-to-back letters of credit?
- Not as such. UCP 600 has an article on transferable credits but none on back-to-back arrangements. Each of the two credits can be issued subject to UCP 600 and is then governed by it as an ordinary credit, independent of the other and of the sale contracts. The link between them exists only in the trader's business and in the care with which the second credit was drafted.
- Why would a trader use a back-to-back credit instead of a transfer?
- Usually because a transfer is unavailable or unsuitable. The buyer may refuse to have its credit marked transferable, or the trader may need terms in the second credit that a transfer cannot give, such as a different currency, different documents, or payment at sight to the supplier while the master pays later. A transfer changes little beyond reducing or shortening the master's terms; a separate credit can be written differently, which is both its use and its risk.
THE IN-TRAY · ONE MINUTE
Make the call on one file.
A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.
1 FILES · PICK A CALL ON ANY OF THEM
5 MORE ON THE ECONOMY · CURRENCY AND TRADE →WHERE DO YOU READ FROM? THE PLACEMENT →
// SUBSCRIBE
The Lab.
One case file and one question, in your inbox every Tuesday morning, New Zealand time. The senior banker's read opens only after you answer.
FREE WITH IT · ANNOTATED PDF
A complete credit paper on a published file, with the approver's notes on what each section has to answer.
No spam. Unsubscribe anytime. Educational content only.