When a buyer and a seller are in different countries and do not know each other well, both are worried. The seller does not want to ship and then wait for money that never comes. The buyer does not want to pay and then receive nothing. A letter of credit, usually called an L/C, solves this by putting banks in the middle.
What Is a Letter of Credit?
A letter of credit is a written promise from the buyer’s bank to pay the seller, as long as the seller presents the documents listed in the L/C, on time and exactly as required. The bank pays against documents, not against the goods themselves. That one point explains most of how L/Cs work.
Most L/Cs follow a set of international rules called UCP 600, published by the International Chamber of Commerce.
Who Is Involved?
- Applicant: the buyer, who asks their bank to open the L/C.
- Issuing bank: the buyer’s bank, which gives the payment promise.
- Beneficiary: the seller, who receives payment.
- Advising bank: a bank in the seller’s country that checks the L/C is genuine and passes it to the seller.
- Confirming bank (optional): a bank that adds its own promise to pay, for extra security.
How an L/C Works, Step by Step
- Buyer and seller agree the deal and that payment will be by L/C.
- The buyer applies to their bank, which issues the L/C.
- The advising bank sends the L/C to the seller.
- The seller checks every condition. If something cannot be met, they ask for an amendment before shipping.
- The seller ships the goods and collects the documents.
- The seller presents the documents to the bank within the time allowed.
- The bank checks the documents. If they comply, the seller is paid (or paid later, for a usance L/C).
- The buyer pays their bank and receives the documents, which they need to collect the goods.
Common Types of L/C
- Irrevocable L/C: cannot be changed or cancelled without the agreement of all parties. Almost all L/Cs today are irrevocable.
- Confirmed L/C: a second bank, usually in the seller’s country, also promises to pay. Useful when the seller is unsure about the buyer’s bank or country.
- Sight L/C: payment is made soon after compliant documents are presented.
- Usance (deferred) L/C: payment is made later, for example 60 or 90 days after shipment. This gives the buyer time to sell the goods.
Which Documents Are Usually Required?
The L/C lists them. Typical ones are the commercial invoice, packing list, bill of lading, certificate of origin, insurance certificate and, for food products, a phytosanitary or health certificate. Our export documents checklist explains each one.
Discrepancies: The Biggest Risk for Sellers
If the documents do not match the L/C, the bank can refuse to pay. These mismatches are called discrepancies. Common ones are:
- Late shipment or late presentation of documents
- Product description on the invoice different from the L/C
- Spelling mistakes in names or addresses
- Missing signatures or missing copies
- Wrong Incoterm or port
The simple fix is to read the L/C line by line as soon as it arrives, ask for amendments early, and prepare all documents from the L/C wording.
What Does an L/C Cost?
Banks charge fees for opening, advising, confirming, amending and checking documents. The total depends on the bank, the amount and the risk of the countries involved. For small orders, the fees can be high compared to the order value, so many traders use L/Cs for first orders and switch to bank transfer once trust is built.
When Should You Use an L/C?
- First orders with a new buyer or supplier
- Large orders where the risk is high
- Deals with countries where payment risk is a concern
Your L/C must also match the agreed Incoterm. If you are not sure about FOB or CIF, read Incoterms 2020 Explained. And before you open any L/C, check that your supplier is genuine. See how to find reliable suppliers.
Trade With Confidence
Rawaani Global works with clear, written terms on every order, and we are happy to work with L/C payment where it suits the deal. Send us your requirement to get started.