What is a letter of credit?
A letter of credit (LC) is a trade finance instrument where a bank undertakes to pay a seller, provided the seller presents the required documents that comply with the credit’s terms.
ICC’s trade finance guide summarizes it simply as a bank guarantee that ensures the seller receives payment provided agreed-upon terms are met.
In real operations terms:
- You are not “proving you shipped”.
- You are presenting documents that match what the LC asked for, within the required timelines.
If you want to avoid surprises, treat the LC as a spec.
Why letters of credit exist
International trade has two core risks:
- the seller worries about getting paid;
- the buyer worries about paying for the wrong goods or non-shipment.
An LC sits between the two and shifts the payment mechanism to a document-driven process that banks can examine.
This is why letters of credit are often used for new counterparties, unfamiliar jurisdictions, or deals where assurance of payment is crucial.
The parties in a letter of credit
Most LCs have at least these roles:
- Applicant: the buyer who requests the LC
- Beneficiary: the seller who will be paid if they present compliant documents
- Issuing bank: the applicant’s bank that issues the LC
- Advising bank: the bank that advises the LC to the beneficiary (often in the seller’s country)
Sometimes you also have:
- Confirming bank: adds its own undertaking to pay (useful when the seller wants to reduce issuing-bank or country risk)
How an LC works (the real workflow)
The clean mental model is a three-stage workflow:
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Issuance The buyer applies; the issuing bank issues the LC text.
-
Execution Seller produces and ships goods, then obtains documents (invoice, transport doc, certificates, etc.) matching LC requirements.
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Presentation and examination Seller presents documents to the nominated bank; banks examine for compliance; payment/acceptance/negotiation happens based on the LC’s availability.
The important part is stage 3.
The strict-compliance principle (why tiny mismatches hurt)
Documentary credits are run on a compliance mindset. That is why “almost right” can still be treated as discrepant.
ICC publishes guidance materials for practitioners around UCP 600 usage, including discussion areas like strict compliance, on-board notations, and documentary credit formats.
Operational takeaway:
- build documents from a single source of truth;
- validate every document against the credit text before presentation.
Key LC dates you must track
If you track only one date, you will eventually lose money.
At minimum track:
- Latest shipment date
- Expiry date (and where the credit expires)
- Presentation deadline (can be a date or a period after shipment)
This is why LC operations teams implement a deadline tracker.
Related how-to: /resources/track-letter-of-credit-expiry
The “required documents” section is where deals break
An LC usually specifies what must be presented. Common examples:
- commercial invoice
- packing list
- transport document (bill of lading or airway bill)
- certificate of origin
- insurance document (only if required)
- inspection certificate (only if required)
If your business ships by sea, the bill of lading is often the most operationally sensitive document. See: /glossary/bill-of-lading
Common LC types (the ones you see in practice)
Your bank will structure specifics, but teams usually encounter these patterns:
- Sight vs deferred/usance: whether payment is at presentation or later
- Confirmed vs unconfirmed: whether another bank adds its payment undertaking
- Transferable: whether the beneficiary can transfer rights to another party
- Standby LC: often used more like a guarantee in certain contexts
Do not guess your obligations based on the “type” label. Always operate off the actual text and timelines.
Digital presentation and eUCP (when documents are electronic)
Some LCs involve electronic presentation or digitally handled documentary credit workflows.
ICC’s eUCP is positioned as a supplement and digital companion to UCP 600 for a digital environment.
Operationally: if your LC references eUCP/electronic presentation rules, you need to treat file formats, submission methods, and receipt timestamps as part of compliance.
When should you use an LC?
LCs introduce cost and operational overhead. Use them when you need the risk control.
Common triggers:
- first deal with a new overseas buyer/seller
- large ticket sizes relative to your working capital
- jurisdictions/banks you want risk protection against
- when the buyer requires bank-driven documentation controls
If you trade frequently with a trusted partner, other instruments (or open account terms) may be more efficient.
How Tijara helps
Tijara helps LC-driven teams run predictable operations by:
- storing LC terms and dates as structured data,
- tracking shipment and presentation deadlines,
- keeping documents aligned to one dataset,
- flagging discrepancies before you present.
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