Letter of Credit (L/C)
An L/C is a conditional payment undertaking issued by the buyer's bank: the seller is paid against documents that comply with the credit's terms, substituting bank credit for commercial trust under the ICC's UCP 600 rules.
A letter of credit (L/C) is a written undertaking issued by the issuing bank, at the importer's (applicant's) request, to pay the exporter (beneficiary) against documents that comply with the credit's terms. It converts the payment obligation from the buyer's commercial trust into bank credit and is a key settlement and financing tool. Most documentary credits are governed by the ICC's Uniform Customs and Practice for Documentary Credits, UCP 600.
The core principle is that L/Cs deal in documents, not goods: banks decide whether to pay solely on the documents and 'strict compliance' applies. For Chinese exporters, the priority is presenting documents that match the credit exactly; otherwise a 'discrepancy' arises and the issuing bank may refuse payment.
Key practical points: under UCP 600 a credit is irrevocable by default; a confirmed L/C adds a second bank's undertaking (useful when there is concern about the issuing bank or country, but at extra cost); examine the credit immediately on receipt and request an amendment for any term you cannot meet; ensure all documents (invoice, B/L, certificate of origin, insurance policy, etc.) are internally consistent and meet the credit's requirements and that presentation is within the expiry and presentation period; L/C-related charges (issuing, advising, negotiation, confirmation fees) are higher than T/T, so allocate costs in your quotation.
FAQ
- What is the first thing to do after receiving an L/C?
- Examine the credit immediately. Check beneficiary/applicant details, amount and currency, goods description, latest shipment and expiry dates, presentation period, and whether you can produce every required document in time. For any term you cannot meet or that conflicts with the PI, request an amendment through the issuing bank before shipping — never ship first and fix later.
- What is a 'discrepancy' and what happens?
- A discrepancy means the presented documents do not conform to the credit (e.g., wrong goods description, late presentation, inconsistent data between documents). When one exists, the issuing bank can refuse payment and funds are held; you may then depend on the buyer waiving the discrepancy to be paid, shifting control to the buyer and sharply raising risk. So documents must be mutually consistent and fully compliant.
- When do I need a confirmed L/C?
- Consider it when you are uncertain about the issuing bank's standing or about political/FX risk in the issuing country. A reputable third bank (often in the exporter's country or a major international bank) adds its own payment undertaking via confirmation. Confirmation carries an extra fee that should be reflected in your pricing.
Related terms
Sources: https://2go.iccwbo.org/ucp-600-uniform-rules-for-documentary-credits-config-1+book_version-Book/ · https://academy.iccwbo.org/trade-finance/e-books/ucp-600/