Letters of Credit: A Complete Guide for Importers and Exporters

Few instruments in international trade finance are as powerful — or as misunderstood — as the letter of credit. Used correctly, an LC transfers the risk of non-payment from the seller to a bank, and the risk of non-delivery from the buyer to documented proof. Used carelessly, it creates expensive disputes, delays shipments, and ties up working capital. This guide explains how LCs work, the main variants, and the circumstances in which they represent the right tool.

What Is a Letter of Credit?

A letter of credit (LC) — also called a documentary credit — is an undertaking by a bank (the issuing bank) to pay a specified amount to a named beneficiary (typically the seller/exporter) upon presentation of documents that comply with the terms of the credit.

The mechanics are as follows:

1. Buyer and seller agree terms — the commercial contract specifies that payment will be made by LC.
2. Buyer instructs its bank (the issuing bank) to issue an LC in favour of the seller.
3. Issuing bank issues the LC to the seller's bank (the advising bank) via SWIFT.
4. Advising bank notifies the seller that the LC has been received and advises its authenticity.
5. Seller ships the goods and assembles the required documents (bill of lading, commercial invoice, certificate of origin, packing list, inspection certificate — depending on the LC terms).
6. Seller presents documents to the advising or nominated bank within the time frame specified.
7. Bank examines documents against the LC terms. If compliant, the bank pays.
8. Issuing bank reimburses the advising/nominated bank and debits the buyer's account.

The fundamental principle is that banks deal in documents, not goods. Whether the goods are as described, whether they meet quality standards, whether the buyer wants them on arrival — none of this is the bank's concern. If the documents comply on their face with the LC terms, the bank is obligated to pay.

UCP 600: The Universal Rules

The Uniform Customs and Practice for Documentary Credits (UCP 600) is the ICC's set of rules governing letters of credit, revised in 2007 and now universally applied in international trade. Almost every LC in international commerce incorporates UCP 600 by reference.

UCP 600 defines:

• The obligations of issuing, confirming, and nominated banks.
• Document examination standards (the five-day rule: banks have five banking days to examine documents after presentation).
• What constitutes a complying presentation.
• The treatment of discrepancies.
• Force majeure provisions.

The strict compliance rule is the cornerstone of LC law: documents must comply with the LC terms exactly. A spelling error in the beneficiary's name, a discrepancy between the invoice description and the LC description, or a bill of lading dated one day after the shipment deadline — all are grounds for the bank to reject documents and decline payment. This is not pedantry: it is the mechanism that protects the buyer's bank from fraudulent or non-conforming presentations.

Sellers must treat LC terms as a precision instrument. Every field in the LC must be deliverable. If any term is unworkable — an unrealistic shipment date, a port not served by the required shipping line — the seller should request an amendment from the buyer before shipment, not after.

Types of Letter of Credit

Irrevocable vs Revocable

Under UCP 600, all LCs are irrevocable by default. A revocable LC — which could be cancelled by the issuing bank without notice to the beneficiary — is no longer recognised by UCP 600. If you encounter a reference to a revocable LC, treat it with extreme caution; it offers the seller no real protection.

Confirmed vs Unconfirmed

An unconfirmed LC carries only the undertaking of the issuing bank (the buyer's bank). If the issuing bank fails to pay — due to insolvency, country sanctions, or political risk — the seller has no additional recourse.

A confirmed LC adds the undertaking of a second bank — typically the advising bank in the seller's country. The confirming bank adds its own irrevocable commitment to pay, independent of the issuing bank. This is particularly valuable when:

• The issuing bank is in a high-risk jurisdiction.
• The buyer is a new counterparty with limited credit history.
• Political or transfer risk in the buyer's country is elevated.

Confirmation costs extra (see fees below), but for large transactions with unfamiliar counterparties, it is often the correct commercial decision.

Sight vs Usance (Deferred Payment)

A sight LC is payable immediately upon presentation of complying documents. This is the standard for sellers who want payment on delivery.

A usance LC (also called a deferred payment LC or term LC) specifies a payment period after the date of documents or after sight — for example, 60 days, 90 days, or 120 days. This creates a form of trade credit: the seller ships and presents documents, but payment is deferred. Buyers use usance LCs to extend their working capital cycle. Sellers who accept usance LCs are effectively extending credit secured by the bank's undertaking.

Under a time draft (acceptance credit), the bank accepts a bill of exchange drawn on it, creating an accepted draft that the seller can potentially discount in the market before maturity. This allows the seller to receive early payment at a discount, while the buyer still pays on the deferred date.

Transferable LC

A transferable LC allows the original beneficiary (typically a trading intermediary) to transfer all or part of the credit to a secondary beneficiary (the actual supplier). This is used when the beneficiary is a middleman who has procured the goods from a third-party manufacturer. Transferable LCs must specifically state that they are transferable; they can generally be transferred only once.

Back-to-Back LC

A back-to-back LC is a separate structure used by intermediaries: the intermediary uses the master LC (received from the end buyer) as collateral to obtain a second LC issued in favour of its supplier. The two LCs are separate instruments — the supplier's bank has no recourse to the master LC. Back-to-back LCs are more complex to administer than transferable LCs and are less commonly used.

Standby Letter of Credit (SBLC)

A standby LC is not a primary payment mechanism. It functions more like a guarantee: it is intended to be called only if the buyer fails to perform its contractual obligations. In normal circumstances, payment is made outside the LC (directly or through open account), and the SBLC sits in the background as a security instrument.

SBLCs are widely used in the US (where traditional bank guarantees are restricted in some states), in real estate transactions, and as bid or performance securities. They are also subject to UCP 600 or, alternatively, the ICC's ISP98 rules (International Standby Practices), which are better suited to the standby context.

Documentary Requirements

A typical LC for a physical goods shipment requires:

• Commercial invoice — matching the LC description of goods exactly.
• Full set of original bills of lading — typically 3/3 originals, made out to the order of the issuing bank (which provides the buyer's bank with control of the goods).
• Certificate of origin — issued by the relevant chamber of commerce or authority.
• Packing list — matching the invoice quantities and descriptions.
• Insurance certificate (if on CIF or CIP terms) — minimum cover as specified.
• Inspection certificate — if required, from a named inspection agency.

Each document must be internally consistent and consistent with every other document. A bill of lading showing 1,000 cartons, an invoice showing 1,000 units, and a packing list showing 990 cartons is discrepant — even if the net weight is the same.

Common sources of discrepancies: presentation after the expiry date; shipment after the latest shipment date; incorrect port of loading or discharge; description of goods not matching LC wording; bill of lading not properly endorsed.

When discrepancies arise, the presenter can: (1) request that the issuing bank waive the discrepancies (which requires the buyer's agreement and is not guaranteed); (2) correct the documents if time allows; or (3) accept payment under reserve (which means the bank pays but retains the right of recourse if the issuing bank rejects).

Bank Fees

LC costs are borne by one or both parties depending on the commercial agreement:

Fee	Typical Range
Issuance (issuing bank)	0.15–0.5% of LC value per quarter
Amendment fee	£100–£500 per amendment
Confirmation (confirming bank)	0.1–0.3% per quarter depending on country risk
Negotiation / examination	0.1–0.2% of document value
Discrepancy fee	£50–£150 per discrepancy
SWIFT transmission	£20–£50

For a £500,000 LC with a 90-day tenor, issuance costs might run to £750–£2,500, with confirmation adding a further £500–£1,500 depending on the issuing bank's country. These costs are significant but should be weighed against the credit risk mitigation provided.

Most LC documentation is issued via SWIFT (MT700 series messages). Banks active in trade finance include HSBC, Barclays Trade, Standard Chartered, Lloyds, Citibank, and specialist trade finance banks.

When to Use a Letter of Credit

An LC is appropriate when:

• New counterparty: you are trading with a buyer or supplier you have not dealt with before and have not yet established mutual trust.
• High political or transfer risk: the buyer's country has a history of payment restrictions, capital controls, or sanctions risk.
• Seller requires certainty before shipment: capital goods, bespoke manufacturing, or long-lead-time products where the seller commits significant resources before delivery.
• Large commodity shipments: iron ore, grain, oil — where the value justifies the administrative cost and the price is fixed to a documentary specification.
• Contractual requirement: project finance, government procurement, or commodities exchanges may mandate LC-backed settlement.

An LC is typically not necessary when:

• You have a long-established trading relationship with a reliable counterparty.
• The transaction value is small relative to the administrative cost.
• Open account trade, with credit insurance, provides adequate protection at lower cost.

Note: the mechanics of letters of credit involve complex legal and banking documentation. Rules and practices can vary by jurisdiction and bank. Always seek specialist trade finance and legal advice before committing to LC-based payment terms in significant transactions.

How Global Investments Can Help

For businesses expanding into new international markets — whether importing goods, exporting services, or entering joint ventures — establishing the right trade finance infrastructure is a prerequisite. Global Investments works with business clients across the international markets we operate in to identify appropriate banking partners and trade finance solutions, including letter of credit facilities.

Whether you are establishing a new import relationship, negotiating payment terms on a major contract, or seeking to reduce trade credit risk as you grow, our team can connect you with specialist trade finance bankers and advisers. Contact us to discuss your requirements.