Letter of Credit Explained: How It Works for Importers and Exporters

A letter of credit (LC) is a written undertaking from a bank to pay a seller a set amount, provided the seller presents documents that comply with the terms of the credit. It replaces the buyer's promise to pay with a bank's promise, which is why exporters and importers who do not know each other well often use it. The price of that protection is paperwork, bank fees and strict document checking. This guide explains how a letter of credit works, the main types, what goes wrong, and how it compares with simpler payment methods.

Who is involved in a documentary letter of credit

A documentary letter of credit involves several parties, each with a defined role:

• Applicant: the buyer who asks their bank to open the credit.
• Issuing bank: the buyer's bank, which issues the credit and promises to pay if documents comply.
• Beneficiary: the seller who receives payment.
• Advising bank: usually a bank in the seller's country that passes the credit to the seller and checks it looks authentic.
• Confirming bank: a bank that adds its own promise to pay on top of the issuing bank's, used when the seller wants extra security.
• Nominated bank: the bank named in the credit as the one where it is available, such as to pay or negotiate.

The key point is that banks deal in documents, not goods. They do not inspect cargo. They check whether the papers presented match the credit.

How the process works step by step

1. Contract. Buyer and seller agree a sale and that payment will be by letter of credit, with the terms written into the contract.
2. Application. The buyer asks the issuing bank to open an LC in the seller's favour.
3. Issue and advice. The issuing bank sends the credit to the advising bank, which informs the seller.
4. Check. The seller reads the credit carefully. If it does not match the contract or cannot be met, the seller asks for an amendment before shipping.
5. Shipment. The seller ships the goods and collects the documents required by the credit.
6. Presentation. The seller presents the documents to the bank within the time allowed in the credit.
7. Examination. The bank checks the documents against the credit. Under the ICC rules, banks have a maximum of five banking days after presentation to examine them.
8. Payment. If the documents comply, the bank pays, or promises to pay at a later date, and the buyer receives the documents to claim the goods.

The rules: UCP 600 and irrevocable credits

Most documentary credits are issued subject to UCP 600, the Uniform Customs and Practice for Documentary Credits published by the International Chamber of Commerce (ICC). It has 39 articles and sets out how banks handle credits, what counts as a complying presentation and how long banks have to examine documents. The ICC says it exists to reduce differences between national and regional practices.

An irrevocable letter of credit cannot be changed or cancelled without the agreement of the issuing bank, the confirming bank if there is one, and the beneficiary. Under UCP 600 a credit is irrevocable even if it does not say so, but check the wording anyway. Always read the credit itself and, for rule details, check the current ICC publication or ask your bank.

Types of letters of credit

• Sight LC. Payment is made when complying documents are presented and accepted.
• Usance (deferred payment) LC. Payment is made at a later date, such as a set number of days after shipment or presentation. This gives the buyer time but means the seller waits.
• Confirmed LC. A second bank adds its promise. Sellers consider this when they have concerns about the issuing bank or the buyer's country.
• Unconfirmed LC. Only the issuing bank has promised to pay.

Other variations exist, such as transferable or revolving credits, and standby letters of credit that act as a payment back-up. Ask your bank which structure fits your trade.

Documents and the discrepancy problem

The documents named in the credit usually include a commercial invoice, packing list, transport document such as a bill of lading, and sometimes a certificate of origin, inspection certificate or insurance document. Each must match the credit exactly in the details that matter: names, goods description, quantities, amounts, dates and ports. Learn how these papers are prepared in our guide to the bill of lading, commercial invoice and packing list.

A mismatch is called a discrepancy. Typical ones include a misspelled name, a late shipment date, an expired credit, a missing signature or a goods description that differs from the credit. Banks can refuse to pay on discrepant documents, though the buyer may agree to waive them. Discrepancies are the main reason sellers experience payment delays under LCs. To reduce them, check the credit as soon as it arrives, ask for amendments before shipping, prepare documents from the credit text rather than from memory, and have your bank or forwarder review them before presentation.

Letter of credit vs wire transfer and other options

In letter of credit vs wire transfer, the wire is faster, cheaper and simpler, but the risk sits with whoever sends or waits for money first. If the buyer prepays, the buyer trusts the seller to ship. If the seller ships on open account, the seller trusts the buyer to pay. An LC shares the risk because payment depends on documents, not trust alone.

• Advantages: bank-backed payment promise, clear document requirements, support for new trading relationships, and sometimes help with financing.
• Disadvantages: bank fees (they vary by bank and country; ask for a written fee schedule), more paperwork, strict documents, delays if there are discrepancies, and credit lines or deposits required from the buyer.

An LC does not protect you from fraud about the goods themselves. If the documents look right but the cargo is wrong, the bank will usually still pay. Pair it with supplier verification and inspection. Our guide on paying overseas suppliers safely compares the main methods, and supplier red flags and sourcing scams helps you spot fake documents and fake suppliers.

When an exporter should consider an LC

For African exporters dealing with a new overseas buyer, an LC can make a large first order possible by replacing an unknown buyer's promise with a bank's. See getting paid by foreign buyers for options. Some banks also offer financing against LC-backed orders; ask what is available. This is general information, not banking advice. Confirm terms, fees and rules with your bank.

Frequently asked questions

Is a letter of credit safe for the seller? It gives strong protection if the documents comply and the issuing bank is sound, but it does not protect against every problem. Check the credit terms and the bank.

What is LC payment timing? A sight LC pays on complying presentation. A usance LC pays at a later date stated in the credit.

Who pays the bank charges? It depends on the contract and credit terms. Agree this in writing.

Can an LC be changed? Yes, by amendment, but an irrevocable credit needs the agreement of the relevant parties, and amendments can take time and cost fees.

What does UCP 600 do? It is the set of ICC rules most LCs follow, setting out how banks must handle documents.

Do small businesses use LCs? Yes, but for smaller orders the fees and paperwork may outweigh the benefit.

Getting started

Before you accept or request an LC, speak to your bank about the form, the fees and the document rules, and make sure your contract matches the credit. To find suppliers who can supply documents and quote clearly, post a sourcing request on Comilmart or browse the catalog. Comilmart connects buyers with verified sellers across Africa.