For first-time importers and exporters, a Letter of Credit (LC) can feel like the most intimidating document in international trade. In reality it is a simple promise: a bank pays the seller, on the buyer's behalf, once the seller presents the right documents. This guide breaks down how documentary credit works, who the parties are, and why your shipping paperwork is the heart of the whole transaction. If you are still arranging carriage, you can find a forwarder on GDS to handle the logistics while the banks handle the money.
What is a Letter of Credit?
A Letter of Credit is a written undertaking by a bank to pay an agreed amount to a seller, provided the seller presents documents that exactly match the terms of the credit. It replaces the buyer's commercial risk with bank risk. The seller no longer worries whether the buyer will pay; the seller only has to satisfy the bank's document requirements. This makes LCs the backbone of trade finance, especially between parties who have never traded before or who operate across high-risk corridors.
The Parties in a Documentary Credit
Four main parties drive every LC. The applicant is the buyer (importer) who asks their bank to open the credit. The beneficiary is the seller (exporter) who will receive payment. The issuing bank is the applicant's bank that issues the LC and carries the payment obligation. The advising bank (usually in the seller's country) authenticates the LC and passes it to the beneficiary. Sometimes a confirming bank adds its own guarantee, giving the seller a local bank to claim from. Understanding who plays which role helps you read the SWIFT MT700 message your bank sends.
Shipping Documents: The Engine of the LC
An LC is settled against documents, not goods, so accuracy is everything. The typical document set includes the Bill of Lading, the commercial invoice, the packing list, and often a certificate of origin and insurance certificate. The Bill of Lading is the most critical because it is the title document for the cargo; if you are unsure how to read one, our guide on how to read a Bill of Lading (HBL vs MBL) explains every field. Because the LC ties payment to delivery terms, your Incoterms 2020 (FOB, CIF, DDP) must align with what the credit demands — a mismatch between an FOB sale and a CIF document set is a classic cause of rejection.
UCP 600: The Rulebook
Almost every commercial LC is issued subject to the Uniform Customs and Practice for Documentary Credits (UCP 600), published by the International Chamber of Commerce. UCP 600 defines how banks examine documents, what counts as a compliant presentation, and the deadlines involved — banks have five banking days to examine a presentation. Crucially, banks deal only with documents and apply the principle of strict compliance: if the documents do not match the LC on their face, the bank may refuse to pay, even if the goods themselves are perfect.
Common Discrepancies
Most LC payment delays come from avoidable document errors. Frequent discrepancies include a late shipment or expired credit, a Bill of Lading that is not "clean on board," inconsistent descriptions between invoice and LC, missing endorsements, incorrect quantities, and a presentation made after the allowed period. Insurance is another trap: if the LC requires cover and your certificate is wrong or absent, the presentation fails. Review our cargo insurance basics guide so the insurance document supports the credit rather than breaking it. When customs and banking deadlines collide, the UAE and GCC customs clearance guide can help you sequence clearance and document release correctly.
LC vs Open Account vs CAD
An LC is not the only way to settle. Under open account, goods ship first and the buyer pays later — cheap and simple, but the seller carries full credit risk. Under Cash Against Documents (CAD), the buyer pays to receive the shipping documents, but no bank guarantees payment, so it sits between open account and an LC in terms of security. An LC is the most secure for the seller and the most demanding administratively. New trading relationships often start with an LC and graduate to open account once trust is built. If you are unsure which structure fits, talk to your forwarder; not sure what they do? Read what is a freight forwarder.
Practical Tips
Read the LC the moment it arrives and check every term against your sales contract. Ask for amendments before shipping, not after. Build a document checklist mapped line-by-line to the credit, and give your forwarder and bank the same checklist. Done well, the LC turns a risky cross-border deal into a predictable, bankable transaction — which is exactly what trade finance is for.
