Letters of Credit

Overview

A letter of credit (LC) is a written undertaking by a bank, issued at the request of a buyer, to pay a seller provided that stated documents are presented in line with the credit's terms. Documentary credits are commonly governed by the ICC's Uniform Customs and Practice for Documentary Credits (UCP 600). The bank deals in documents, not in the goods themselves.

How it generally works

1. Buyer and seller agree to use an LC in their sales contract.
2. The buyer asks its bank to issue the LC in favour of the seller.
3. The seller ships the goods and presents the required documents.
4. The banks check the documents against the credit; if they comply, payment is made or promised as the LC provides.

Potential business use cases

• First-time trade between parties without an established relationship.
• Shipments to or from markets where payment risk is a concern.
• Transactions where the seller needs a bank commitment before shipping.

General documentation

Requirements vary by transaction, country and institution. Commonly requested items include:

• Sales contract or proforma invoice
• Application for the LC (completed with the issuing bank)
• Commercial invoice, packing list, and transport document
• Certificates of origin, inspection, or insurance if the LC requires them
• Import or export permits where applicable

Important considerations

• Small discrepancies between documents and the LC terms can delay or prevent payment.
• LCs involve bank fees, and sometimes margin or collateral requirements.
• Issuing an LC is the decision of the bank, not of an intermediary.

FAQs