Letter of credit (L/C)
An irrevocable bank undertaking to pay the seller upon presentation of compliant documents. A cornerstone instrument of international trade finance.
A letter of credit (L/C) is a written undertaking by a bank (issuing bank), at the request of the buyer (applicant), to pay the seller (beneficiary) a specified amount, provided that the seller presents documents that strictly comply with the terms and conditions of the credit.
This mechanism is governed by the Uniform Customs and Practice for Documentary Credits (UCP 600) published by the International Chamber of Commerce (ICC), applied in over 175 countries. The L/C rests on two fundamental principles:
- Autonomy: the credit is independent from the underlying commercial contract
- Strict compliance: the bank examines only the documents, not the goods
In practice, the buyer requests their bank to issue an L/C in favour of the seller. The seller ships the goods, assembles the required documents (commercial invoice, bill of lading, certificate of origin, etc.) and presents them to the bank. If compliant, payment is made.
The letter of credit provides maximum security for both parties. Its cost (0.5 % to 3 % of the amount) is justified for high-risk transactions, new trading partners or politically unstable countries.