Definition
A letter of credit (LC) is a financial instrument issued by a bank that guarantees payment to a seller (beneficiary) when specified documentary conditions are met. It is governed internationally by the ICC's UCP 600 rules.
Why it matters for traders
The LC is the backbone of trust in international trade. Without it, exporters face non-payment risk and importers face non-delivery risk. Proper LC management prevents costly discrepancies, expiry misses, and amendment delays.
Main types of LCs
- Sight LC — Payment is made immediately upon presentation of compliant documents
- Usance (Deferred) LC — Payment is made at a future date specified in the credit terms
- Confirmed LC — A second bank (usually in the exporter's country) adds its own guarantee
- Revolving LC — Automatically renews for multiple shipments under the same terms
- Transferable LC — Allows the beneficiary to transfer all or part of the credit to another party
- Standby LC (SBLC) — Acts as a payment guarantee of last resort, not a primary payment method
Key parties involved
- Applicant — The buyer/importer who requests the LC from their bank
- Issuing bank — The buyer's bank that creates and guarantees the LC
- Beneficiary — The seller/exporter who receives payment under the LC
- Advising bank — The bank that notifies the beneficiary of the LC
- Confirming bank — An additional bank that adds its own payment guarantee
Common LC discrepancies
Discrepancies are the #1 cause of LC payment delays. The most frequent include:
- Late presentation of documents after the expiry date
- Inconsistent descriptions of goods across documents
- Missing required documents or insufficient copies
- Bill of lading not marked "freight prepaid" when required
- Insurance coverage amount below the LC minimum (usually 110% of invoice value)
Operational example
An importer in Dubai opens a sight LC for USD 250,000 with a supplier in Mumbai. The LC requires: commercial invoice, packing list, bill of lading, certificate of origin, and insurance certificate. The supplier ships the goods and presents documents to their bank. If all documents comply with the LC terms, the issuing bank must pay within the timeframe specified — typically 5 banking days after document receipt under UCP 600.