What is a letter of credit?
A letter of credit (LC) is a bank's written promise to pay a seller a set amount once the seller presents shipping and other documents that match the LC's terms. It puts the bank's credit in place of the buyer's, so the seller relies on a bank rather than on a buyer it may not know. Example (round numbers): a US importer orders 200,000 dollars of machinery from Vietnam. Its bank issues an LC requiring a bill of lading, a commercial invoice and a packing list; when the supplier ships and presents matching documents, the bank pays 200,000 dollars.
- A letter of credit is a bank's commitment to pay the exporter when documents that comply with its terms are presented.
- Banks deal in documents only, not goods; the LC is a separate contract from the sale.
- Most LCs follow UCP 600, the current edition of the ICC rules that have governed letter of credit transactions worldwide for more than 85 years.
- A confirmed LC adds a second bank, usually in the exporter's country, that promises to pay if the issuing bank does not.
- The US Trade Finance Guide calls LCs one of the most secure payment methods but labor intensive and relatively expensive.
How a letter of credit works
The importer (the applicant) asks its bank to open an LC in favor of the exporter (the beneficiary). The issuing bank sends it to the exporter's bank, which checks it is genuine and passes it on. The exporter ships, then presents the documents the LC lists. If they comply, the bank pays and the importer's bank releases the documents so the importer can collect the goods and clear customs.
Unless it says otherwise, an LC is irrevocable: it cannot be changed or cancelled unless the importer, the banks and the exporter agree. Most LCs are issued subject to the International Chamber of Commerce's UCP 600 rules, whose articles cover credits versus contracts (Article 4), the standard for examining documents (Article 14), the commercial invoice (Article 18) and the bill of lading (Article 20).
| Party | Who it is | Role |
|---|---|---|
| Applicant | Importer | Asks its bank to open the LC and repays the bank |
| Beneficiary | Exporter | Ships and presents documents to be paid |
| Issuing bank | Importer's bank | Promises payment against complying documents |
| Advising bank | Usually the exporter's bank | Tells the exporter the LC exists and checks it is authentic |
| Confirming bank | Usually the exporter's bank | Adds its own promise to pay if the issuing bank fails to |
Sources: ITA Trade Finance Guide, chapter 4; ICC, UCP 600. As published on 29 October 2026.
Where a business meets it
LCs are recommended for higher-risk situations: a new trading relationship, a buyer whose credit cannot be checked, or a market where political upheaval, devaluation or exchange controls could put payment at risk. Special forms include a transferable LC, a revolving LC that restores its amount after each drawing, and a standby LC, which is drawn only if the buyer fails to pay.
Common mistakes
- Documents that do not match. Discrepancies can stop payment. The Trade Finance Guide advises having documents prepared by trained professionals.
- Terms the exporter cannot meet. Check shipment dates, ports and required certificates before the LC is issued, not after.
- Expecting the bank to inspect the goods. Banks examine documents only; quality disputes stay between buyer and seller.
- Accepting an unconfirmed LC from a weak bank. Without confirmation, the exporter carries the issuing bank's and country's risk.
Related terms and how Helm handles it
A documentary collection also uses banks to exchange documents for payment, but without a bank's promise to pay. Key documents are the bill of lading and the commercial invoice.
Letters of credit are issued by banks. Helm arranges trade finance, including supplier finance, receivables finance and working capital, case by case; see trade finance.
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What is a letter of credit in simple terms?
It is a bank's promise to pay a seller once the seller proves, with documents, that it shipped the goods as agreed. The seller relies on the bank's credit instead of the buyer's.
Who pays for a letter of credit?
The importer applies for the LC and pays its bank to provide it. The International Trade Administration advises exporters to ask their bank what an LC costs and who pays the fees before the importer applies.
What is a confirmed letter of credit?
It is an LC to which a second bank, usually in the exporter's country, adds its own promise to pay. The exporter is then paid by the confirming bank against complying documents even if the issuing bank does not pay.
What rules govern letters of credit?
Most LCs state that they are subject to UCP 600, the International Chamber of Commerce's Uniform Customs and Practice for Documentary Credits. It defines key terms and sets the standard banks use to examine documents.
References
- International Trade Administration: Trade Finance Guide (2022 edition)
- International Trade Administration: Methods of payment, Letter of Credit
- ICC Academy: UCP 600, Uniform Customs and Practice for Documentary Credits
- World Trade Organization: Trade finance
This guide is general information for businesses, not financial, legal or tax advice. Rules, fees and timings were checked against the sources listed on the review date and may change.