What is LC (Letter of Credit )?

Key Parties Involved​

​

1. Applicant (Buyer/Importer): Requests the LC from their bank to facilitate payment.

2. Beneficiary (Seller/Exporter): Receives payment upon fulfilling LC terms.

3. Issuing Bank: The buyer’s bank that guarantees payment under the LC.

4. Advising Bank: The seller’s bank, which verifies and forwards the LC to the beneficiary.

5. Confirming Bank(optional): Adds an extra layer of payment security by guaranteeing the LC alongside the issuing bank.

​​

Operational Mechanism​

​

1. Contract Agreement: Buyer and seller agree to use an LC in their sales contract.

2. LC Issuance: The buyer applies to their bank (issuing bank) to open an LC in favor of the seller.

3. LC Notification: The advising bank reviews and informs the seller of the LC’s terms.

4. Shipment and Documentation:

· The seller ships the goods and prepares documents (e.g., bill of lading, commercial invoice, insurance certificate).

· Documents must strictly comply with the LC’s requirements (e.g., “clean” bills of lading, on-time submission).

5. Payment Release:

· The seller submits documents to the advising/confirming bank.

· If documents meet the LC’s terms, the bank releases payment to the seller.

· The issuing bank reimburses the advising/confirming bank and debits the buyer’s account.

​

Types of LCs​

​

1. Sight LC: Payment is made immediately upon compliant document submission.

2. Usance LC (Deferred Payment): Payment is deferred to a future date (e.g., 60 days post-shipment).

3. Revocable vs. Irrevocable LC:Irrevocable LCs cannot be modified without all parties’ consent, offering stronger security.

​Standby LC: Functions as a safety net, activated only if the buyer defaults.

4. Revolving LC: Automatically renews for multiple shipments under a single agreement.

​

​Importance in Freight and Trade​

​

· Risk Reduction: Protects sellers from non-payment and buyers from non-delivery.

· Financing Tool: Banks may offer loans against LCs to improve cash flow for exporters.

· Compliance Enforcement: Strict documentation requirements ensure adherence to shipment timelines, quality standards, and regulatory rules (e.g., Incoterms®).

· Global Acceptance: Governed by standardized rules , LCs are recognized worldwide.

​​

Practical Considerations​

​

1. Documentary Compliance: Even minor discrepancies (e.g., typos, missed signatures) can delay payment.

2. Costs: Fees (e.g., issuance, confirmation) are typically borne by the buyer but may be negotiated.

3. Timeliness: Delays in document submission or cargo readiness can void LC validity.

4. Fraud Risks: Fake or non-compliant documents may lead to disputes; due diligence is critical.