{"id":3037,"date":"2026-09-02T10:00:26","date_gmt":"2026-09-02T08:00:26","guid":{"rendered":"https:\/\/mwtsourcing.com\/?p=3037"},"modified":"2026-10-06T03:32:52","modified_gmt":"2026-10-06T01:32:52","slug":"letter-of-credit","status":"publish","type":"post","link":"https:\/\/mwtsourcing.com\/en\/letter-of-credit\/","title":{"rendered":"Letter of credit : complete guide & definition"},"content":{"rendered":"

In 2023, the <\/span>International Chamber of Commerce<\/b> estimated that trade finance instruments, including letters of credit, supported over <\/span>$18 trillion in global trade transactions<\/b>. That number alone tells you why understanding this payment mechanism matters for anyone involved in cross-border sourcing.<\/span><\/p>\n

Whether you’re importing goods from <\/span>China<\/b> or managing complex supplier relationships across multiple countries, a documentary credit can be the difference between a smooth transaction and a costly dispute.<\/span><\/p>\n

What is a letter of credit, exactly ?<\/b><\/h2>\n

A <\/span>letter of credit (LC)<\/b> is a financial document issued by a bank on behalf of a buyer, guaranteeing that a seller will receive payment once specific conditions are met. It acts as a formal commitment from the issuing bank, not from the buyer directly. This distinction matters enormously in practice.<\/span><\/p><\/blockquote>\n

Think about sourcing from a factory in <\/a><\/span>Guangzhou<\/a> for the first time. The supplier doesn’t know you, doesn’t trust your ability to pay, and won’t ship $200,000 worth of goods on a handshake. Meanwhile, you’re not about to wire funds before seeing the products loaded onto a vessel. A <\/span>documentary credit bridges exactly this trust gap<\/b>, placing a reputable financial institution as the guarantor between both parties.<\/span><\/p>\n

The core principle is simple : the bank promises to pay the exporter <\/span>if and only if<\/span><\/i> the documents presented match precisely what the LC specifies. Those documents typically include a <\/span>commercial invoice, bill of lading, packing list<\/b>, and sometimes certificates of origin or inspection reports.<\/span><\/p>\n

When managing supplier compliance across multiple SKUs and factories, verifying that these documents align with purchase order terms is a daily operational reality.<\/span><\/p>\n

Letters of credit are governed by the <\/span>UCP 600<\/b> rules (Uniform Customs and Practice for Documentary Credits), published by the International Chamber of Commerce in 2007 and still the global standard today.<\/span><\/p><\/blockquote>\n

These rules define how banks interpret documents and handle discrepancies, making the LC one of the most standardized instruments in international trade finance.<\/span><\/p>\n

How a letter of credit works : the key parties and their roles<\/b><\/h2>\n

\"Two<\/p>\n

Understanding the mechanics requires knowing who does what. Four main actors interact in a standard LC transaction :<\/span><\/p>\n\n\n\n\n\n\n\n
Party<\/b><\/td>\nRole<\/b><\/td>\nResponsibility<\/b><\/td>\n<\/tr>\n
Applicant (buyer\/importer)<\/b><\/td>\nRequests the LC from their bank<\/span><\/td>\nDefines conditions, pays bank fees<\/span><\/td>\n<\/tr>\n
Issuing bank<\/b><\/td>\nIssues the LC on behalf of the buyer<\/span><\/td>\nGuarantees payment if documents comply<\/span><\/td>\n<\/tr>\n
Advising\/confirming bank<\/b><\/td>\nLocated in the exporter’s country<\/span><\/td>\nNotifies seller, may add its own guarantee<\/span><\/td>\n<\/tr>\n
Beneficiary (seller\/exporter)<\/b><\/td>\nReceives payment upon compliance<\/span><\/td>\nPrepares and submits required documents<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

The process flows in a clear sequence. Once the buyer and seller agree on trade terms, the buyer applies for an LC at their bank. The issuing bank then transmits the LC to the advising bank in the exporter’s country.<\/span><\/p>\n

The seller ships the goods, compiles the required documents, and presents them to the advising bank, which forwards everything to the issuing bank for verification. If documents are compliant, <\/span>payment is released within the agreed timeframe<\/span><\/i>, usually five banking days under UCP 600.<\/span><\/p><\/blockquote>\n

When sourcing from Chinese manufacturers<\/a>, a common complication arises : factories sometimes struggle to produce perfectly compliant documentation. <\/span>Even minor discrepancies, like a date format or a weight unit<\/b>, can trigger a refusal and delay payment by weeks. Having a structured document checklist before shipment is not optional, it’s operational discipline.<\/span><\/p>\n

The different types of letters of credit you’ll encounter<\/b><\/h2>\n

Not all LCs work the same way. Choosing the wrong type for your transaction can expose you to unnecessary risk or unnecessary costs. Here are the main variants used in international procurement :<\/span><\/p>\n