Letters of credit, end to end

A documentary letter of credit (LC) is the workhorse of cross-border trade payment. Instead of trusting an unknown buyer to pay, the seller trusts the buyer's bank, which promises to pay against a defined set of compliant documents. It's governed by a global rulebook, the ICC's UCP 600.

Who's who

Applicant

The buyer, who asks their bank to open the LC.

Issuing bank

The buyer's bank, which issues the LC and undertakes to pay.

Beneficiary

The seller, who will be paid if they present compliant documents.

Advising bank

A bank in the seller's country that authenticates and passes on the LC.

Confirming bank

A bank that adds its own guarantee to the LC, so the seller doesn't rely on a foreign issuing bank.

The flow

1. 1Buyer and seller agree to pay by LC and write the required documents into the sale contract.
2. 2The buyer applies; the issuing bank opens the LC and sends it to the advising (and possibly confirming) bank.
3. 3The seller checks the LC matches the contract, then ships the goods.
4. 4The seller presents the required documents to the bank within the deadlines.
5. 5The bank examines the documents against the LC terms. If they comply, it pays. If not, it can refuse.
6. 6Documents are passed to the buyer, who uses the bill of lading to claim the cargo.

Types worth knowing

• Sight vs. usance (deferred) — paid on presentation, or at a later date (e.g. 90 days).
• Confirmed vs. unconfirmed — whether a second bank guarantees payment.
• Transferable — lets a middleman transfer the credit to their own supplier.
• Back-to-back — a separate LC opened to the supplier on the strength of the buyer's LC.
• Revolving — reinstates automatically for repeat shipments.