Letter of Credit Explained for Exporters

A letter of credit (LC) is a bank's undertaking to pay the exporter, provided the exporter presents documents that comply with the LC's terms. It shifts the payment risk from the buyer to a bank — which is why LCs remain one of the most important tools for exporters dealing with new buyers or higher-risk markets.

The Parties

• Applicant: the buyer, who asks their bank to issue the LC
• Issuing bank: the buyer's bank, which issues the LC and undertakes to pay
• Beneficiary: the exporter, who will be paid
• Advising bank: a bank in the exporter's country that authenticates and advises the LC to the exporter
• Confirming bank (optional): a bank that adds its own undertaking to pay
• Nominated bank: a bank authorised to pay, accept, or negotiate under the LC

How It Works, Step by Step

1. Buyer and exporter agree on a contract with payment by LC.
2. The buyer applies to their bank to issue the LC.
3. The issuing bank issues the LC and sends it to the advising bank.
4. The advising bank checks authenticity and advises the LC to you.
5. You check the LC carefully against your contract and capabilities.
6. You produce and ship the goods.
7. You present the required documents to the nominated or advising bank within the LC's deadlines.
8. Banks examine the documents against the LC terms.
9. If the documents comply, the issuing bank pays — immediately for a sight LC, or at a future date for a usance LC.
10. The buyer pays the issuing bank and receives the documents to collect the goods.

The Rules: UCP 600

Most LCs are subject to the ICC's Uniform Customs and Practice for Documentary Credits (UCP 600). Banks examine documents under UCP 600 and international standard banking practice (published by the ICC as ISBP). Key principles:

• Banks deal in documents, not goods. They check documents, not whether the goods are as described.
• Documents must comply with the LC terms, UCP 600, and standard banking practice.
• LCs under UCP 600 are irrevocable — they cannot be changed or cancelled without the agreement of the parties, including the beneficiary.
• Unless the LC says otherwise, documents must be presented no later than 21 calendar days after shipment, and in any case within the LC's expiry date.

Sight vs Usance LCs

• Sight LC: payment is made when compliant documents are presented.
• Usance (deferred payment or acceptance) LC: payment is made at a future date — for example 60 or 90 days after shipment or presentation. Exporters can often discount usance LCs with their bank to get paid earlier, at a cost.

Confirmed LCs

If you are concerned about the issuing bank or the buyer's country — for example currency controls or political risk — you can ask for the LC to be confirmed by a bank you trust, often in your own country or a major financial centre. The confirming bank then undertakes to pay you if documents comply, regardless of whether the issuing bank pays. Confirmation has a cost, but can be well worth it.

What to Check When You Receive an LC

• Your company name and address spelt exactly right
• Amount and currency match the contract, including tolerance if quantities may vary
• Product description matches your goods and invoice
• Latest shipment date and expiry date are achievable
• Port of loading and discharge are correct
• Partial shipments and transhipment allowed or prohibited as needed
• Required documents are obtainable — and in the form specified
• Incoterm matches the contract
• Charges — which party pays which bank charges
• No unusual clauses you cannot control, such as documents to be signed by the buyer ("soft clauses")

Common Discrepancies

Many first presentations under LCs contain discrepancies. Common ones include:

• Late shipment or late presentation
• Description of goods on the invoice not matching the LC
• Inconsistent data between documents — weights, quantities, marks
• Missing documents or signatures
• Bill of lading not showing "on board" notation or showing clauses
• Insurance document dated after shipment or insufficient cover
• Amounts exceeding the LC value

When documents are discrepant, the issuing bank may refuse to pay — though it may approach the buyer to waive discrepancies. The buyer then has leverage, and payment may be delayed.

Soft Clauses: A Warning

Be cautious of LC clauses that make payment depend on something outside your control — for example, a certificate that must be signed by the buyer, or goods arriving to the buyer's satisfaction. These effectively turn the LC into an unsecured payment. Ask for them to be removed.

Costs

LCs involve bank charges — advising, confirmation, negotiation, amendment, and discrepancy fees. The contract should state which party pays which charges. Build your share into your price. See export costing sheet.

When to Use an LC

LCs are most useful when:

• Dealing with a new buyer
• The order value is significant
• The buyer's country carries economic or political risk
• The buyer cannot or will not pay in advance

For established buyers, simpler methods like documentary collections or open account may be appropriate. See export payment methods.

Frequently Asked Questions

Is a letter of credit a guarantee of payment?

An LC is the issuing bank's undertaking to pay if you present complying documents. It is only as reliable as the issuing bank and your ability to present compliant documents. Confirmation by a trusted bank adds protection.

What is a confirmed letter of credit?

A confirmed LC carries an additional undertaking to pay from a second bank, usually in the exporter's country or a major financial centre, protecting the exporter against issuing bank and country risks.

What happens if my LC documents have discrepancies?

The issuing bank may refuse to pay, but it can seek the buyer's waiver. If the buyer accepts, payment proceeds, but you lose the protection of the LC and may face delays or renegotiation.

How long do I have to present documents under an LC?

Under UCP 600, unless the LC states otherwise, documents must be presented within 21 calendar days after shipment and no later than the LC's expiry date.