What is a Letter of Credit (LC)?
A letter of credit — properly a documentary credit — is an undertaking by a bank to pay the seller a stated amount, provided the seller presents documents that comply exactly with the credit's terms. It substitutes the bank's creditworthiness for the buyer's.
At a glance
| Term | LC (Letter of Credit) |
|---|---|
| Definition | Bank-issued payment instrument guaranteeing the seller will be paid on presentation of compliant shipping documents. |
| Category | Payment & banking |
| Related terms | MT-103, MT-700, MT-799, T/T Payment, POF (Proof of Funds), BCL (Bank Comfort Letter), Performance Bond |
What it is used for
Letters of credit exist because buyer and seller in different countries do not have to trust each other. The seller ships knowing a bank is obliged to pay against documents; the buyer pays knowing documents evidencing shipment must be presented first.
Key points
- Most credits are governed by the ICC's UCP 600 rules, under which a credit is irrevocable unless it says otherwise.
- Banks deal in documents, not goods: payment turns on whether the presentation complies, not on cargo condition.
- Common variants: sight (pay on presentation), usance or deferred (pay later), confirmed (a second bank adds its undertaking), transferable, and standby.
- Typical required documents are the bill of lading, commercial invoice, packing list, certificate of origin and an inspection certificate.
What to watch for
- Discrepancies are the main failure mode — a large share of first presentations are rejected over document errors, not fraud.
- Ask for confirmation by a bank in your own jurisdiction when the issuing bank or country carries risk.
- Check that the required documents are ones you can actually obtain within the presentation period.
Frequently asked questions
What is the difference between a confirmed and unconfirmed LC?
In a confirmed credit a second bank, usually in the seller's country, adds its own independent undertaking to pay. The seller then relies on that bank rather than the issuing bank abroad.
What is a standby letter of credit?
A standby is a guarantee-like instrument: it is drawn on only if the other party fails to perform, rather than being the intended route to payment.
What happens if documents are discrepant?
The issuing bank may refuse to pay. The buyer can waive the discrepancies, but is not obliged to, which is why document preparation matters so much.
Related terms
Lodfy verifies every company on the platform — registration, ownership and sanctions screening — before they can trade.