If you’re an exporter looking for a secure way to receive payments from international buyers, a Letter of Credit (LC) can be a reliable option. But let’s be honest, figuring out how to apply for one can feel a bit overwhelming, especially if you’re new to the process.
The good news? It’s not as complicated as it seems.
In this quick guide, we’ll walk you through the Letter of credit process, explain which documents you’ll need, and highlight a few things to keep in mind. We will keep it simple so you can actually make the most of what LC has to offer. Let’s dive in.
A Quick Look at Letter of Credit and its Key Types
A Letter of Credit (LC) is a commitment issued by a bank (usually the buyer’s or importer’s bank) to secure international payment that ensures you, the seller/exporter, get paid in full once you meet all the LC’s conditions. These conditions usually require you to present certain documents (like a bill of lading, invoice, packing list, etc.) that prove shipment or delivery of the goods. This arrangement takes the risk out of international trade and serves as a safety net for both the buyer and the seller. While the buyer receives goods in the promised quality, the seller gets the payment as agreed.
Types of LCs
You don’t have to know all the types of LC, but it’s useful to know what kind you need. A few common ones include:
| Type of LC | How It Works | Best Use Case |
|---|---|---|
| Sight LC | You get paid once the buyer’s bank verifies that your documents meet the LC terms. | When you want faster payment after shipment. |
| Usance / Deferred Payment LC | Payment is made after an agreed period, such as 30, 60, or 90 days. | When you offer the buyer credit terms. |
| Confirmed LC | A second bank, usually in your country, adds its own payment guarantee in addition to the buyer’s bank. | When you want extra payment protection. |
| Transferable LC | The LC can be transferred, fully or partly, to another beneficiary such as your supplier. | Useful for traders or middle parties working with suppliers. |
Check with your buyer and your bank to choose the right one for your transaction.
UCP 600: What are they and why are they important?
The Uniform Customs and Practice for Documentary Credits (commonly referred to as UCP 600) are a set of international rules issued by the International Chamber of Commerce (ICC). Their main objective is to bring uniformity and consistency to global banking practices related to Letters of Credit (LCs).
UCP 600 rules apply only when they are explicitly incorporated into the LC. This can be done by referencing them in Field 40E of the SWIFT MT700 message format. Although the UCP 600 is a voluntary code, it governs the majority of Letters of Credit used worldwide due to its wide acceptance in international trade.
The UCP 600 came into effect in July 2007, replacing the earlier UCP 500. It was introduced to reduce ambiguity in interpretation and to minimize the chances of document rejection due to unclear terms.
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Other Related Rules
- ISBP 745 (International Standard Banking Practice): Designed to be read alongside UCP 600, this guide helps interpret terms that UCP 600 does not define, such as “shipping documents” and “shipping marks.” While informative, ISBP is not automatically incorporated into the LC.
Content of a Letter of Credit (LC)
A Letter of Credit must include several important pieces of information to ensure its validity and clarity. These key details typically include:
| • The date on which the Letter of Credit is issued. |
| • The full name and address of the beneficiary (i.e., the exporter). |
| • The total amount to be credited under the Letter of Credit. |
| • The expiration date of the LC. |
| • Complete bank details of the beneficiary, along with the LC number and all applicable terms and conditions. |
| • The signature of the authorized bank official issuing the LC. |
Key Benefits of LC
Compared to traditional payment methods like cash transactions or wire transfers, Letters of Credit (LCs) offer enhanced protection against the uncertainties and risks involved in international trade. LC payments provide greater assurance that sellers will receive payment on time, while the structured nature of an LC payment can also make it easier for businesses to access working capital financing.
For Buyers
Import Letters of Credit can help safeguard your international purchases and often give you the leverage to negotiate more favorable contract terms, such as extended credit periods from your suppliers.
When you apply for a Letter of Credit:
- You demonstrate to your supplier that you have the financial capacity to pay for the goods.
- You have the option to define specific terms within the LC related to shipping, delivery timelines, insurance coverage, and product quality inspections by your suppliers.
For Suppliers
Export Letters of Credit significantly reduce the risk of non-payment and make it easier to access funds without needing an existing credit line.
When you receive a Letter of Credit:
- You gain a payment commitment from the buyer’s bank, provided your submitted documents fully meet the conditions outlined in the LC.
- In many cases, you can also request advance funding against documents that are compliant with the LC terms.
Advantages vs Disadvantages of a Letter of Credit
A quick comparison of the benefits and limitations of using a Letter of Credit (LC) in international trade
Documents Required to Apply for a Letter of Credit
Documents to Open an LC (Submitted by the Importer)
- LC application-cum-agreement (signed and stamped)
- Importer Exporter Code (IEC)
- KYC of the business and signatories (PAN, GST certificate, Aadhaar, passport)
- Board resolution (company) or partners’ authority letter (partnership)
- Sales contract or proforma invoice
- Sanctioned credit limit or cash margin
- Import licence (only for restricted goods)
Documents the Exporter Presents for Payment
- Commercial invoice
- Bill of lading or airway bill
- Packing list
- Insurance certificate
- Certificate of origin
- Bill of exchange (if required)
- Inspection certificate (if required)
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Applying for a Letter of Credit: Step-by-Step Instructions
Things to Watch Out For
Applying for an LC isn’t rocket science, but a few small mistakes can lead to delays or non-payment. Here are a few tips:
| • | Double-check names, dates, and values in all documents. |
| • | Always keep a close eye on shipment and expiry dates. |
| • | Keep communication open with your buyer. |
| • | Work with a CHA or logistics partner who understands LC processes. |
| • | Don’t wait until the last minute, as LCs take time to process. |
What Are the Charges for a Letter of Credit
Banks levy fees for issuing Letters of Credit, usually calculated as a percentage of the total amount being guaranteed. The exact charges can vary based on several factors, such as:
| • | The type of Letter of Credit being issued. For example, confirmed LCs generally come with higher fees. |
| • | The overall complexity and duration of the deal or trade agreement. |
| • | Creditworthiness of the issuing bank. |
As an example, a bank might charge around 0.76% of the guaranteed amount. This makes it a fairly reasonable cost for businesses seeking secure and reliable international payment terms.
Conclusion
In case you are in a more risky situation, say you deal with an importer who has an unsure financial background or you are entering a new business partnership with a long payment term, the Letter of Credit will become your financial protection.
Nevertheless, one should understand that filling out all the documents according to all the requirements may be quite complicated. In order not to run any risks because of the slightest mistake in the form or content, it is better to entrust this work to some professional specialists.
Besides, do not wait till the buyer opens the Letter of Credit and apply for it yourself. You should clarify some aspects of its functioning, namely:
- For what size of export transactions a Letter of Credit is suitable?
- What expenses will it bring and who will pay for them?
- How will it be settled in case of disputes between the buyer and the seller?
It is very important to understand the lc opening process before the transaction begins.
If you want to avoid extra trouble related to some miscommunication, it is better to ask some specific questions before you start the export business transaction.
FAQs
Only the importer can open an LC by applying at their bank. The exporter can ask the buyer to open one.
The exporter ships before the latest shipment date in the LC and submits the documents within 21 days of shipment, before the LC expires.
The bank flags a discrepancy and payment may be delayed. The importer can accept it, or the exporter can correct the documents and submit them again.
