Letter of Credit Explained: How It Protects Buyers and Sellers

A letter of credit (LC) is one of the most searched payment terms in international trade because it solves a real problem: neither party fully trusts the other yet.

The core idea

Instead of the buyer paying the seller directly, the buyer's bank guarantees payment to the seller, provided the seller presents documents that exactly match the LC's terms — quality of goods is not verified, only document compliance.

The parties involved

• Applicant — the buyer, who requests the LC from their bank
• Issuing bank — the buyer's bank, which issues the guarantee
• Beneficiary — the seller, who receives payment
• Advising/confirming bank — often the seller's local bank, which verifies the LC's authenticity (and, if "confirmed," adds its own payment guarantee)

The typical process

1. Buyer and seller agree on LC as the payment term and finalize a proforma invoice
2. Buyer applies to their bank to open the LC, specifying exact required documents
3. Seller ships the goods and presents the commercial invoice, bill of lading, and other required documents to their bank
4. If documents comply exactly with the LC terms, payment is released

Why exact document compliance matters so much

Banks deal in documents, not goods — a single discrepancy (a misspelled company name, a date outside the shipment window) can cause the bank to reject the presentation and delay or block payment, even if the actual goods are fine.

Frequently asked questions

What's the difference between a sight LC and a usance LC?

A sight LC pays immediately upon compliant document presentation; a usance LC defers payment to a set future date, effectively giving the buyer short-term credit.

Who pays the bank fees for a letter of credit?

This is negotiable and should be specified in the sales contract — commonly split, or assigned to whichever party requested the LC.

Related tools and reading

• International Payment Methods Guide
• Essential Trade Documents Guide
• Glossary: Standby Letter of Credit

Conclusion

A letter of credit trades speed and simplicity for security — it's the right tool when trust between trading partners hasn't been established yet, and worth the extra documentation discipline it demands.

Prepare the documents an LC will require: Create a commercial invoice →