Letters of Credit: A Practitioner’s Primer

A letter of credit is one of the oldest instruments in trade finance, and still one of the most misunderstood outside the desks that process them daily. At its core, it does one thing: it substitutes a bank’s creditworthiness for a buyer’s, so that a seller in one country can trust payment from a buyer in another they have never met.

What a Letter of Credit Actually Does

An issuing bank, acting on an applicant’s (the buyer’s) instructions, undertakes to pay a beneficiary (the seller) a specified sum, provided the beneficiary presents documents that comply exactly with the terms of the credit. This is the detail that trips up newcomers: a letter of credit is a documents transaction, not a goods transaction. Banks examine paperwork, not cargo. A shipment can arrive in perfect condition and still go unpaid if the documents presented do not match the credit’s terms.

The Parties Involved

• Applicant — the buyer, who instructs their bank to issue the credit.
• Issuing Bank — the applicant’s bank, which undertakes to pay.
• Advising Bank — typically the beneficiary’s bank, which authenticates and forwards the credit.
• Confirming Bank — optionally adds its own payment undertaking, usually where the issuing bank’s country or credit standing warrants extra assurance.
• Beneficiary — the seller, who ships the goods and presents documents for payment.

The Documents That Matter

Every credit specifies its own document set, but most transactions revolve around a small core, checked under UCP 600 and, where invoked, ISBP practice:

• Commercial invoice — must match the credit’s description of goods precisely, not approximately.
• Bill of lading or transport document — evidences shipment and, in most trades, controls title to the goods.
• Certificate of origin — required wherever preferential duty or import eligibility depends on it.
• Packing list — supports the invoice and transport document with shipment detail.
• Insurance certificate — required whenever the credit’s Incoterm places risk on the buyer during transit.

Where Letters of Credit Go Wrong

In practice, the overwhelming majority of delayed or refused payments trace back to discrepancies — a misspelled name, a late shipment against the credit’s latest shipment date, an invoice value that does not tie to the credit amount, a missing endorsement. None of these are exotic failures. They are ordinary paperwork errors that a documentary credit, by design, does not forgive.

A letter of credit protects a seller from a buyer’s unwillingness to pay. It does not protect a seller from their own paperwork.

A working principle, not a proverb

A Practical Checklist

1. Read the credit in full before shipment, not after — every field, every date, every tolerance.
2. Confirm the goods description in the credit matches the commercial contract exactly.
3. Check shipment and expiry dates against realistic production and transit timelines, with margin.
4. Verify which bank confirms, and whether that confirmation is actually needed for the counterparty risk involved.
5. Reconcile every document against every other document before presentation — banks will.

None of this replaces judgement built over years of desks, discrepancies, and the occasional dispute resolved at the counter rather than in court. But it is the discipline that keeps a documentary credit doing what it was built to do: turning trust between strangers into a bankable transaction.