Letter of Credit (LC) is one of the most secure payment methods in international trade. Both buyer and seller are protected with bank guarantee. In this article, we will examine all aspects of letters of credit in detail.
What is a Letter of Credit?
A letter of credit is a written commitment by the importer’s bank (issuing bank) to the exporter’s bank (advising/confirming bank) that payment will be made upon fulfillment of certain conditions.
Key Parties
- Applicant: The importer who opens the LC
- Beneficiary: The exporter to whom LC is opened
- Issuing Bank: The bank that opens the LC
- Advising Bank: The bank that advises the LC
- Confirming Bank: The bank that confirms the LC
Letter of Credit Advantages
For Exporter:
- Bank-guaranteed payment
- Elimination of buyer risk
- Country risk reduction (confirmed LC)
- Financing opportunity (discount)
For Importer:
- Document-based payment guarantee
- Quality control (through documents)
- Building supplier trust
- Term payment opportunity
Types of Letters of Credit
1. Revocable / Irrevocable
Revocable LC:
- Issuing bank can cancel unilaterally
- No longer used (UCP 600)
Irrevocable LC:
- Cannot be changed without consent of all parties
- Standard practice
2. Confirmed / Unconfirmed
Unconfirmed LC:
- Only issuing bank is responsible
- Lower cost
Confirmed LC:
- Advising bank also gives payment commitment
- Issuing bank and country risk eliminated
- Additional cost (confirmation fee)
When to Get Confirmation:
- If issuing bank is unknown
- If country risk is high
- If political instability exists
- Large value transactions
3. By Payment Type
At Sight Payment:
- Payment when documents presented
- Most advantageous for exporter
Deferred Payment (Usance):
- Payment at specified term
- 30/60/90/120/180 days common
- Payment convenience for importer
Acceptance Credit:
- Term with draft acceptance
- Bank acceptance
Mixed Payment:
- Partial advance + partial deferred
4. Special Types
Revolving LC:
- For recurring shipments
- Automatic renewal
- Continuous supply relationships
Back-to-Back LC:
- For transit trade
- Second LC with main LC as security
Transferable LC:
- Beneficiary can transfer rights
- Intermediary firm transactions
Standby LC:
- Guarantee purpose
- Activates if obligation not fulfilled
Letter of Credit Process
Stage 1: Commercial Agreement
- Sales contract is made
- Payment method determined as LC
- LC terms agreed
Stage 2: LC Opening
- Importer applies to bank
- Bank conducts credit evaluation
- LC text prepared
- LC opened and sent via SWIFT
Stage 3: Advice and Review
- Advising bank receives LC
- Authenticity check performed
- Advised to exporter
- Exporter reviews LC terms
Stage 4: Shipment and Document Preparation
- Products shipped
- Required documents prepared
- Documents prepared in compliance with LC terms
Stage 5: Document Presentation
- Documents submitted to bank
- Advising bank examines documents
- If compliant, sent to issuing bank
Stage 6: Payment
- Issuing bank checks documents
- If compliant, payment instruction given
- Payment made to exporter
- Importer receives documents
LC Documents
Mandatory Documents
1. Commercial Invoice
- Seller-buyer information
- Goods description
- Unit price and total amount
- LC number
2. Transport Document
- Sea: Bill of Lading (B/L)
- Air: Air Waybill (AWB)
- Road: CMR
- Multimodal: Combined Transport B/L
3. Insurance Policy/Certificate
- For CIF/CIP delivery terms
- Minimum 110% value
4. Packing List
- Package details
- Weight information
Optional Documents
- Certificate of Origin
- Quality Certificate
- Inspection Report
- Halal/Organic Certificate
- Fumigation Certificate
Document Discrepancy
Common Discrepancies
- Late Shipment: Shipment date after deadline
- Late Presentation: Exceeding document presentation period
- Inconsistent Information: Goods description, quantity differences
- Missing Documents: Required document not presented
- Format Errors: Signature, date, place of issue
Discrepancy Consequences
- Issuing bank may reject payment
- Issuing bank may accept under reserve
- Importer may provide waiver
- Discount/penalty may apply
Prevention Methods
- Read LC terms carefully
- Use checklist
- Work with document specialist
- Choose experienced carrier
- Allow sufficient time
Letter of Credit Costs
Importer Costs
| Cost Item | Rate/Amount |
|---|---|
| Opening commission | 0.1-0.3% / quarter |
| SWIFT fee | $50-100 |
| Amendment fee | $50-100 |
| Document examination | $75-150 |
Exporter Costs
| Cost Item | Rate/Amount |
|---|---|
| Advising commission | 0.05-0.1% |
| Confirmation commission | 0.3-1.5% / quarter |
| Discount interest | Libor + spread |
| Transfer fee | $100-200 |
UCP 600 Rules
UCP 600 published by ICC sets the standard rules for letter of credit transactions.
Important Articles
Article 14: Standard Document Examination
- Banks look at face of documents
- 5 business days examination period
- Consistency check
Article 16: Discrepancy Notice
- Reasons for rejection must be stated
- Must be notified at once
- Option to hold/return documents
Article 36: Force Majeure
- Force majeure situations
- Limitation of bank liability
Practical Recommendations
For Exporters
-
Negotiate LC Terms
- Realistic shipment date
- Sufficient document presentation period
- Obtainable documents
-
Pay Attention to Document Preparation
- Use checklist
- Have independent review
- Keep backup documents
-
Confirmation Evaluation
- Analyze country and bank risk
- Make cost-benefit calculation
For Importers
-
Set Clear LC Terms
- Clarify product description
- Flexible but protective terms
- Request applicable documents
-
Bank Selection
- Experienced trade finance unit
- Appropriate cost structure
- Fast transaction capacity
-
Supplier Communication
- Share LC draft in advance
- Minimize amendment needs
Conclusion
Letter of credit is an important tool that ensures the security of parties in international trade. A properly structured LC minimizes risks for both exporter and importer.
As Gökçe Trade, we provide consultancy services in your international payment processes. We are with you at every stage from supplier selection to document follow-up in your LC transactions.
Contact us for trade finance.