Answer
A Letter of Credit (L/C) is a written undertaking by a bank, issued on behalf of a buyer/importer, to pay the seller/exporter a specified amount provided the seller presents the required documents strictly complying with the L/C terms.
Why is an L/C required?In international trade, the buyer and seller may be in different countries and may not know or trust each other.
The seller worries:
- “Will I get paid after shipping the cargo?”
The buyer worries:
- “Will the seller actually ship the agreed goods?”
The L/C reduces this commercial risk because the bank stands between buyer and seller.
Typical sequence:
Buyer → asks bank to issue L/C → Seller ships goods → Seller presents documents → Bank checks documents → Payment made if documents comply
A very important point is:
Banks deal with documents, not with the actual goods.
So the bank checks documents such as:
- Bill of Lading
- Commercial invoice
- Packing list
- Insurance document/certificate
- Certificate of origin
- Inspection certificate, if required
The rules commonly governing documentary credits are UCP 600 — Uniform Customs and Practice for Documentary Credits, issued by the International Chamber of Commerce.
Core Types of Letters of Credit:
| Type of LC | Key Mechanism | Best Used For |
| Irrevocable LC | Cannot be amended or canceled without the consent of all parties (Buyer, Seller, and Issuing Bank). Standard default under UCP 600 rules. | Standard international trade transactions. |
| Confirmed LC | A second bank (usually the seller's local bank) adds its guarantee to pay, backing up the issuing bank. | High-risk countries or financially unstable issuing banks. |
| Unconfirmed LC | Guaranteed solely by the issuing bank; the advising bank merely passes documents without financial liability. | Standard transactions between stable banking systems. |
| Sight LC | Payment is made immediately upon presentation and verification of compliant shipping documents (within 5 banking days). | Immediate cash settlement transactions. |
| Usance / Time LC | Payment is deferred to a fixed future date (e.g., 30, 60, or 90 days after Bill of Lading date). | Buyer requires time to sell cargo before paying. |
| Standby LC (SCLC) | Acts as a secondary safety net; paid out only if the buyer defaults on a underlying commercial contract. | Performance guarantees and backup credit facilities. |
| Transferable LC | Allows the primary beneficiary (middleman) to transfer all or part of the credit to a secondary supplier. | Intermediaries and trading houses without liquid capital. |
| Revolving LC | Automatically renews its value across multiple shipments over a set time frame without issuing a new LC each time. | Regular, repeated shipments between established partners. |
| Back-to-Back LC | The beneficiary uses an incoming LC from their buyer as collateral to issue a separate LC to their own supplier. | Intermediary transactions involving strict confidentiality. |