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Letters of Credit

When you're selling to a buyer you don't know well, in a country where legal recourse is difficult, getting paid can feel like the biggest risk in the deal. A letter of credit (LC) is the international trade mechanism designed to solve exactly that problem. Used correctly, it gives the exporter a bank's guarantee of payment — provided the right documents are presented on time and in perfect order.

Many UK exporters encounter LCs for the first time when a large overseas buyer requests one. Understanding how they work — and where they go wrong — will save you considerable stress.

What a Letter of Credit Is

A letter of credit is a written undertaking issued by a bank (the issuing bank, acting on behalf of the buyer) to pay the seller a specified amount, provided the seller presents a defined set of compliant documents within a defined timeframe. The bank is not paying for the goods — it is paying for the documents. This is a critical distinction: the bank does not care whether the goods are what the buyer expected; it cares only whether the documents match the LC terms exactly.

For the buyer, the LC gives confidence that payment will only be released when documents evidencing shipment have been presented. For the seller, it provides a bank's guarantee rather than relying on the buyer's promise to pay.

The Parties Involved

The applicant is the buyer, who requests the LC from their bank.

The issuing bank is the buyer's bank, which issues the LC in favour of the seller. The issuing bank's credit risk is the buyer's home country — which may give the seller limited comfort if it's in a high-risk jurisdiction.

The beneficiary is the seller (you, as the UK exporter), in whose favour the LC is issued.

The confirming bank is a bank in the seller's country (often the seller's own bank) that adds its own guarantee to the LC. A confirmed LC means payment is guaranteed by a UK bank regardless of what happens to the issuing bank or in the buyer's country. For exports to higher-risk markets, insisting on a confirmed LC significantly reduces risk.

The advising bank simply notifies the seller that an LC has been issued, without adding a guarantee.

How the LC Process Works

The typical flow runs as follows: the buyer and seller agree commercial terms including that payment will be by LC. The buyer instructs their bank to issue an LC in the seller's favour. The issuing bank sends the LC to an advising or confirming bank in the UK. The seller reviews the LC terms carefully before shipping anything. The seller ships the goods and gathers the required documents. The seller presents the documents to the confirming or advising bank within the LC's validity period. The bank checks the documents against the LC terms. If compliant, payment is made or acceptance given. If discrepancies are found, the seller must correct them or seek the buyer's waiver.

Documents Typically Required Under an LC

Every LC specifies its own document requirements, but the most common are:

• Commercial invoice: Must match the LC exactly — same description of goods, same value, same currency, same buyer and seller details.
• Bill of lading or airway bill: The transport document evidencing shipment. For sea freight, a full set of original negotiable bills of lading is typically required.
• Packing list: Matching the invoice and showing the physical details of the shipment.
• Certificate of origin: Often required, specifying the country of manufacture. Some LCs require a Chamber-certified certificate; others accept a supplier declaration.
• Insurance certificate: Required under CIF Incoterms, showing the goods are insured for at least 110% of the invoice value.

The Importance of Strict Compliance

Banks apply a standard of strict compliance — even a minor discrepancy between the documents and the LC terms can result in the bank refusing to pay until the discrepancy is resolved. Common discrepancies include: a description of goods on the invoice that doesn't word-for-word match the LC, a late presentation of documents after the LC's expiry date, a shipment date after the latest shipment date specified in the LC, and inconsistencies between documents (e.g., quantities that don't match between the invoice and packing list).

The practical implication is that you should review the LC in full before shipping and raise any problematic terms with the buyer immediately. Amending an LC after the fact is possible but takes time and costs money. It is far better to catch problems before the goods leave your warehouse.

LC vs Other Payment Methods

Open account (pay after delivery) is the norm for established trading relationships in low-risk markets, but carries full credit risk for the exporter.

Documentary collection uses banks to exchange documents for payment, but the banks do not guarantee payment — they simply act as intermediaries. It's cheaper than an LC but offers less protection.

An LC is most appropriate for new buyer relationships, high-value shipments, and exports to markets where credit risk or political risk is elevated. The cost (LC fees typically run to 0.5–2% of the transaction value) is often worthwhile insurance for a significant export order.