Letter of Credit Explainer
A commercial letter of credit is a bank’s commitment, issued for a buyer, to pay a seller when the seller presents documents that comply with the credit’s terms. It is widely used in international trade when the parties need more assurance than an open-account promise.
The buyer applies to an issuing bank, which sends the credit through an advising bank. After shipment, the seller presents required documents, such as a transport document, invoice, or certificate. Banks examine documents, not the physical goods, and pay or accept a draft if the presentation complies.
A confirmed letter of credit adds a second bank’s payment undertaking, which can reduce issuing-bank or country risk for the seller. Fees, collateral, deadlines, document wording, and discrepancy handling matter. Minor inconsistencies can delay payment or require the buyer to waive discrepancies.
The instrument does not guarantee product quality or eliminate fraud, political, currency, logistics, or performance risk. Align the sales contract and credit, use experienced trade professionals, verify the issuing bank, prepare documents precisely, and understand that changes usually require agreement among relevant parties.
Payment depends on presenting the documents required by the letter of credit.
The bank normally evaluates documents rather than inspecting the goods.
A confirming bank adds its own undertaking to pay a complying presentation.
That protection carries cost and depends on the confirmation terms.
Names, dates, amounts, shipping terms, and documents must match the credit.
Careful drafting and document review reduce delays and waivers.
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