Who bears the risk in a red clause letter of credit?

The importer, through the issuing bank. The bank that advances the money relies on the issuing bank's undertaking in the clause to repay it if the supplier fails to present shipping documents, and the issuing bank recovers from the importer under its credit application. The advance itself is usually unsecured, resting on a receipt and an undertaking from the supplier. A green clause, which asks for proof that the goods are already stored, reduces that risk without removing it.

What is the difference between a red clause and a green clause letter of credit?

Both let the beneficiary draw part of the credit before shipment. A red clause usually asks only for a receipt and an undertaking to ship. A green clause asks in addition for evidence that the goods have been bought and are held in storage, such as a warehouse receipt, often with insurance. That gives the banks something to look to if the goods do not ship, and is why green clauses are sometimes used for larger advances.

How is the advance under a red clause repaid?

Normally out of the credit itself. When the supplier presents complying shipping documents, the paying bank deducts the advance and its interest from the amount due and pays the balance. If no complying documents are presented before the credit expires, the advancing bank claims repayment from the issuing bank under the clause, and the issuing bank charges its customer. The credit states who bears the interest on the advance.

Are red clause letters of credit still used?

They are a specialised tool rather than an everyday one, found mainly in commodity and seasonal trades where suppliers need cash to buy or harvest before they can ship. A buyer that wants to fund a supplier has other routes: a direct prepayment against an advance payment guarantee, or leaving the supplier's own bank to provide pre-shipment finance. Each puts the risk of non-shipment somewhere other than on the buyer's unsecured claim.

// WORKED EXAMPLEWHERE THE RISK SITS

Red Clause Letter of Credit: Who Carries the Advance

The supplier is paid before it ships, and the buyer is the lender.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-07

// THE SHORT ANSWER

A red clause turns a buyer's letter of credit into working capital for its supplier. Part of the credit can be drawn before anything ships, so a producer that must pay for crops or raw materials first is funded through the buyer's bank rather than its own. The advance comes back out of the payment when the shipping documents are presented. If they are not, the bank that advanced is repaid by the issuing bank, and the issuing bank by the buyer. The risk of a supplier that takes the money and does not ship ends with the buyer.

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.

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// 01 — WHY A BUYER FUNDS ITS OWN SUPPLIER

Some suppliers cannot ship without money first: a growers' cooperative that pays farmers at harvest, a processor buying raw material in season, a small manufacturer with no working-capital line. Their own banks may not lend against an order from a buyer abroad. A buyer that needs the goods can solve that by paying part of the price early, and a red clause is a way of doing so through the letter of credit it is already arranging, so that the advance and the final payment run through the same banks and the same document.

The name is usually said to come from the clause once being written in red ink, to catch the eye of the bank that would pay against it. What matters now is not the colour but the wording, because the clause is the only place the advance is governed.

// 02 — HOW THE CLAUSE WORKS

The ICC's rules for documentary credits, UCP 600, contain no article on advances before shipment. The red clause is a term the credit itself adds, and its text commonly settles five things:

Who may advance the advising, confirming or other nominated bank

How much a stated amount or share of the credit

Against what a receipt and an undertaking to ship and present;

in a green clause, evidence the goods are in store

Repayment deducted, with interest, from the payment due

when complying documents are presented

If nothing ships the issuing bank repays the advancing bank, with

interest, and recovers from the applicant

The last line is what makes the advance bankable. The advancing bank lends to a supplier it may know, but it relies on the issuing bank's undertaking in the clause, so its risk is the issuing bank's. The issuing bank is owed in turn by its customer, the importer, under the credit application. Nothing secures the money while it is in the supplier's hands. A green clause narrows that gap by allowing the advance only against evidence that the goods are stored, often insured, which gives the banks something to point to.

// 03 — THE EXAMPLE

A coffee roaster, constructed for this page like every figure in it, buys a season's green coffee for US$1.2m from a growers' cooperative abroad. The cooperative must pay its growers at harvest, ten weeks before the beans are dried, graded and shipped. The roaster's bank issues a credit with a red clause allowing the advising bank to advance up to 25% of the credit against the cooperative's receipt and undertaking, with interest at 7% a year for the cooperative's account. The share and the rate are the example's, not a market norm.

Credit amount 1,200,000

Advance at harvest, 25% 300,000

Interest 300,000 × 7% × 72 ÷ 360 = 4,200

At presentation, 72 days after the advance:

Due under the credit 1,200,000

Less advance and interest − 304,200

Paid to the cooperative 895,800

The roaster's bank counted the full US$1.2m against the roaster's limit from the day it issued the credit. From harvest, US$300,000 of it was no longer a promise against documents but money already advanced, which the bank must repay if the supplier on the other side of the world does not ship.

Change one fact. Rain spoils the drying and the cooperative ships nothing before the credit expires. The advising bank claims US$304,200 from the issuing bank under the clause; the issuing bank pays and debits the roaster. The roaster's remedy is a claim against the cooperative under the sale contract and the undertaking it signed, pursued in the supplier's country. In substance the roaster made a US$300,000 unsecured loan to its supplier, and its bank lent the roaster the money to do it.

// 04 — HOW IT DIFFERS FROM OTHER WAYS TO PAY EARLY

Pre-shipment finance, sometimes called packing credit, is the supplier's own bank lending against an export order or an incoming credit. The risk of non-shipment then sits with that bank, on its customer. Under a red clause it sits with the buyer.

A prepayment backed by an advance payment guarantee also moves cash to the supplier early, but the buyer pays directly and holds a bank's undertaking to repay on demand if the supplier does not perform. The buyer's risk is then on the guaranteeing bank rather than on the supplier. A red clause carries no such guarantee unless the credit or the sale contract calls for one.

Within documentary credits, the green clause is the secured cousin, and the usance credit is the mirror image: it lets the buyer pay after shipment, where a red clause has it pay part before.

DEFINED IN ONE PARAGRAPH → · PRE-SHIPMENT FINANCE → · ADVANCE PAYMENT GUARANTEES →

// 05 — WHERE IT DECIDES A FILE

For the importer's banker a red clause puts two exposures in one credit: the usual commitment to pay against documents, which the documents and goods partly secure, and the advance, which nothing secures. A credit paper can name the advance for what it is, unsecured lending to a foreign supplier on the importer's account, and ask the questions that go with it: how long the importer has bought from this supplier, whether earlier advances were shipped against in full, and whether the importer could absorb the loss if they were not.

The negotiation is over the wording. A smaller share, a green clause, an advance released in stages, or a guarantee from the supplier's bank each shrink the unsecured part. The importer's bank may ask for cash cover against the advance, or hold it within a tighter limit. Whether to offer the clause is the importer's commercial decision; how much of it the bank will carry is the credit decision.

HOW BANKS READ EXPORTERS → · PRODUCT FILE: TRADE LOAN →

// 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 1 and 4 — The rules apply to a credit that incorporates them unless the credit expressly modifies or excludes them, and contain no article on advances before shipment, so a red clause takes effect as a term of the credit itself — section 02.

// QUESTIONS PEOPLE ASK

Who bears the risk in a red clause letter of credit?: The importer, through the issuing bank. The bank that advances the money relies on the issuing bank's undertaking in the clause to repay it if the supplier fails to present shipping documents, and the issuing bank recovers from the importer under its credit application. The advance itself is usually unsecured, resting on a receipt and an undertaking from the supplier. A green clause, which asks for proof that the goods are already stored, reduces that risk without removing it.
What is the difference between a red clause and a green clause letter of credit?: Both let the beneficiary draw part of the credit before shipment. A red clause usually asks only for a receipt and an undertaking to ship. A green clause asks in addition for evidence that the goods have been bought and are held in storage, such as a warehouse receipt, often with insurance. That gives the banks something to look to if the goods do not ship, and is why green clauses are sometimes used for larger advances.
How is the advance under a red clause repaid?: Normally out of the credit itself. When the supplier presents complying shipping documents, the paying bank deducts the advance and its interest from the amount due and pays the balance. If no complying documents are presented before the credit expires, the advancing bank claims repayment from the issuing bank under the clause, and the issuing bank charges its customer. The credit states who bears the interest on the advance.
Are red clause letters of credit still used?: They are a specialised tool rather than an everyday one, found mainly in commodity and seasonal trades where suppliers need cash to buy or harvest before they can ship. A buyer that wants to fund a supplier has other routes: a direct prepayment against an advance payment guarantee, or leaving the supplier's own bank to provide pre-shipment finance. Each puts the risk of non-shipment somewhere other than on the buyer's unsecured claim.

THE IN-TRAY · ONE MINUTE

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A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

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.

What happens to its margin?

5 MORE ON THE ECONOMY · CURRENCY AND TRADE →WHERE DO YOU READ FROM? THE PLACEMENT →

THE GLOSSARYIN ONE PARAGRAPHRed clause letter of credit What is a red clause letter of credit, and who carries the risk of the advance?