Letters of Credit Explained: A Practical Guide for Exporters

Letters of Credit remain one of the most reliable tools for exporters seeking payment security. When used correctly, they reduce risk, unlock financing, and build trust in new trade relationships. Exporters who master LCs gain a competitive advantage and avoid costly mistakes that can delay payment.

A Letter of Credit (LC), also known as a Documentary Credit, is a written commitment issued by a bank on behalf of an importer, guaranteeing payment to an exporter provided that specific documents are presented in strict conformance with the terms of the credit. It is one of the most widely used instruments in international trade.

Key Components

• Applicant (the importer who instructs their bank to issue the LC)
• Issuing bank (the importer's bank that issues the LC)
• Beneficiary (the exporter who will receive payment)
• Advising/confirming bank (the exporter's bank that notifies or adds its guarantee)
• Complying documents (shipping documents, commercial invoice, B/L, etc.)
• Expiry date and place of presentation

How It Works

The importer applies to their bank for a Letter of Credit in favour of the exporter. The issuing bank sends the LC to the exporter's bank (advising bank), which notifies the exporter. The exporter ships the goods, compiles all required documents and presents them to their bank. If the documents comply with the LC terms, the issuing bank is obligated to pay. A confirmed LC adds the advising bank's own payment guarantee, removing country risk for the exporter.

Benefits

• Payment guaranteed by the bank, not dependent on the importer's creditworthiness
• Exporter is protected as long as compliant documents are presented
• Importer protected, payment only releases upon document compliance
• Transferable and assignable in certain structures
• Accepted globally under UCP 600 rules, providing legal certainty

Challenges

• Strict document compliance required; even minor discrepancies cause rejection
• Complex and time-consuming to prepare and check documents
• Bank charges at multiple stages (issuance, confirmation, negotiation)
• Ties up the importer's credit line with their bank
• Not suited to fast-moving or informal trade relationships

Types of Letters of Credit

The most common form of LC is the Irrevocable Letter of Credit, which cannot be amended or cancelled unless all parties agree. It provides exporters with a high level of certainty because the issuing bank is firmly committed to honouring the LC once compliant documents are presented.

A confirmed LC adds an extra layer of protection. In this structure, a second bank, usually located in the exporter’s country, guarantees payment alongside the issuing bank. Exporters typically request confirmation when dealing with high‑risk countries, buyers with weak credit profiles, or banking systems that lack stability.

A Sight LC offers immediate payment upon presentation of compliant documents, making it ideal for exporters who need fast liquidity. In contrast, a Usance or Deferred Payment LC delays payment for a specified period, such as 30, 60, or 90 days, allowing buyers more time to manage cash flow.

Finally, a Transferable LC allows the exporter to pass part or all of the LC value to another supplier. This is particularly useful for trading companies or intermediaries who rely on upstream suppliers to fulfil the order.

The LC Process: Step by Step

The LC workflow begins during contract negotiation, when both exporter and buyer agree that payment will be made through an LC. Once the contract is signed, the buyer requests the LC from their bank. The LC is then sent to the exporter’s bank for advising, where its authenticity is verified.

After the LC is confirmed as genuine, the exporter proceeds with shipment and prepares the required documents. These documents are then presented to the exporter’s bank, which forwards them to the issuing bank for examination. If everything complies with the LC terms, the bank releases the payment.

Common LC Documents

Most LCs require a familiar set of trade documents, including the commercial invoice, packing list, bill of lading, certificate of origin, insurance certificate, and, where applicable, an inspection certificate. These documents must match the LC terms precisely, which is why exporters must handle them with care.

The Biggest LC Risk: Discrepancies

A discrepancy occurs when the documents presented do not match the LC requirements. Even small errors, such as misspelt names, incorrect HS codes, late shipment dates, missing signatures, inconsistent Incoterms, or mismatched details across documents, can lead to delays or even non‑payment.

To minimise discrepancies, exporters should work from a detailed document checklist and, where possible, partner with a consulting firm or freight forwarder experienced in LC documentation. Many banks will also pre‑check draft documents before final submission. Above all, LC terms should be kept as clear, simple, and realistic as possible.

Letter of Credit Costs

LCs involve several fees, including issuance, confirmation, negotiation, amendment, and discrepancy charges. The total cost depends on factors such as the buyer’s country risk, the issuing bank’s credit rating, the LC amount, and the tenor. Exporters should factor these costs into pricing discussions early in the negotiation process.

When LCs Are the Best Option

Letters of Credit are particularly valuable when dealing with new buyers, high‑value shipments, or markets with elevated political or economic risk. They are also well‑suited to buyers with limited credit history or transactions that require strict, detailed documentation.

When LCs Are Not the Best Option

For low‑value shipments or long‑standing buyers with a strong payment record, LCs may be unnecessarily complex and costly. They are also less suitable in markets where reliable fintech payment rails exist or when the exporter cannot fully control the documentation process.

General Application Requirements

• Credit facility or cash collateral at the importer's bank
• Formal trade contract or proforma invoice
• Full description of goods, quantity, and value
• Agreed shipment terms (Incoterms: FOB, CIF, etc.)
• List of required documents and their specifications
• KYC documentation for both applicant and beneficiary

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