Letter of Credit Explained — How L/C Works in International Trade
A Letter of Credit is the safest payment method in international trade but one of the least understood. This guide explains exactly how it works, what documents are needed, and common mistakes to avoid.
A Letter of Credit (L/C) is a payment instrument issued by a bank on behalf of a buyer (importer), guaranteeing payment to the seller (exporter) once specific conditions are met and documents presented. It is the most widely used payment method for large international commodity transactions.
How a Letter of Credit Works — Step by Step
1. Buyer and seller agree on L/C payment terms in the sales contract 2. Buyer applies to their bank (Issuing Bank) to open the L/C 3. Issuing Bank sends the L/C to Seller's bank (Advising Bank) 4. Seller ships goods and presents required documents to Advising Bank 5. Advising Bank checks documents for compliance 6. If documents comply, Issuing Bank pays the Seller 7. Issuing Bank releases documents to Buyer to claim goods at port
Required Documents (Standard)
•Commercial Invoice - Bill of Lading (B/L) or Airway Bill - Packing List - Certificate of Origin - Certificate of Analysis / Quality Certificate - SGS or Third-Party Inspection Certificate - Phytosanitary Certificate (for agricultural products) - Insurance Certificate (if CIF terms)
Types of L/C
•Sight L/C: Payment made immediately upon document presentation - Usance/Term L/C: Payment made X days after document presentation (30, 60, 90 days) - Irrevocable L/C: Cannot be changed without consent of all parties — always use this - Confirmed L/C: Additional guarantee added by Advising Bank — use for high-risk countries
Common Mistakes to Avoid
Discrepancies in L/C documents are the #1 cause of payment delays. Common errors include: spelling mistakes in beneficiary name, incorrect description of goods vs. L/C wording, wrong port names, and missing documents. Always have an experienced trade finance officer review documents before presentation.