Letters of credit, and when they are worth it

The buyer asks their bank to issue a credit in the exporter's favour. The bank issues it, and from that moment the bank — not the buyer — owes the exporter payment against a defined set of documents. That is the whole mechanism, and everything surprising about letters of credit follows from it.

Because the promise belongs to the bank, it does not depend on the buyer's later opinion of the goods. The ICC states the principle of autonomy in terms: the credit "has its own terms and conditions which do not rely upon the terms or performance of the sales contract". A buyer who has opened a credit and then finds a problem cannot simply instruct the bank to withhold payment. If the documents comply, the bank pays.

Which means the honest description is that an L/C converts your credit risk into your bank's credit risk, in the exporter's favour. That is exactly what a supplier who does not know you wants, and it is why an L/C often unlocks an order that would otherwise require a much larger deposit.

And it is why "I will pay by L/C so I am protected" is the wrong sentence. What you are protected against is paying for a shipment that was never made and never documented. You are not protected against the shipment being wrong, late, short, or of the wrong specification — none of those are things the bank looks at.

The practical consequence: an L/C is a payment mechanism, not a quality mechanism, and it belongs alongside an inspection regime rather than instead of one.

Everything the bank does is document examination. Does the invoice match the credit, does the transport document show what the credit requires, are the dates within the windows the credit sets, do the descriptions agree across the set. A presentation that satisfies all of it is complying and gets paid. A presentation that does not is discrepant, and the issuing bank may refuse it.

The examination happens inside a defined window. Under the current rules, the ICC notes that sub-article 14(b) "no longer refers to a reasonable time and limits the examination period to a maximum of five banking days following the day of presentation". Five banking days is not five days — weekends and bank holidays at either end are excluded — and there are banks in the chain at both ends. This is the main reason an L/C transaction feels slow to people used to wiring a balance.

A discrepancy does not have to be serious to stop payment. A description that reads differently from the credit, a document dated a day outside a window, a set that is missing a copy the credit required — these are enough. The bank is not being obstructive; it is doing the only job the rules give it, which is comparing paper to paper.

When a presentation is discrepant, the practical outcome is usually negotiation rather than disaster: the exporter corrects the documents if there is time, or the buyer is asked to waive the discrepancy. But notice what a waiver means from the buyer's side — you are being asked to authorise payment on a presentation that did not comply, and once you waive, the protection is gone. Read what you are waiving rather than treating it as paperwork.

This page does not publish a rate at which presentations are refused, and it does not walk through the rulebook article by article. The rules are the ICC's published work with a precise wording; a paraphrase of them in a guide is the kind of confident summary that is subtly wrong in the case that matters. Use the rules, and have the bank that will actually examine your documents confirm the reading.

The order is large enough that the bank charges and the administration are small against the value at stake. There is no threshold that can be published here, because the charges are per-bank, per-corridor and per-amount — ask your own bank for the schedule on your actual amount before deciding, not after.

The real risk is the counterparty's ability to be paid, not the quality of the goods. An L/C is a payment instrument. If what keeps you awake is whether the product will meet specification, an L/C addresses none of it and an inspection regime addresses all of it.

The supplier will not start without security, and the alternative is a much larger deposit. This is the case where an L/C is unambiguously good for the buyer: it substitutes your bank's credit for a large cash outlay, and your money stays with you until documents are presented.

The transaction is complex enough that documentary discipline is worth having. Multiple shipments, a long lead time, a route with several hand-offs — a credit forces the terms, the dates and the documents to be agreed in advance and in writing, which is work that repays itself.

And the cases where it is the wrong tool: a small first order, an established relationship where the terms already work, and any situation where the risk you are actually managing is quality. In those, the cost and the delay buy you something you did not need.

The commonest expensive mistake is a credit whose terms the supplier cannot satisfy. Every document the credit calls for must be one that genuinely exists for this shipment, issued by a party who will actually issue it, within a window that the real production and shipping schedule allows. A credit that requires a document nobody can produce does not protect you; it guarantees a discrepancy and a renegotiation.

Write the shipment and expiry dates against the real schedule, with slack. Production slips, vessels roll, and an amendment costs money and days at a point when both are short. Agreeing a realistic latest shipment date at the start is free.

Keep the document descriptions short and identical to what will appear on the exporter's paperwork. A long specification copied into the credit has to be reproduced exactly on the invoice; every extra clause is another opportunity for a mismatch that stops payment for reasons that have nothing to do with the goods.

An inspection certificate can be made a required document, and it is the one way to give the credit any connection to the goods at all. But be careful who issues it: a certificate the buyer alone can withhold gives the buyer a veto over payment, and a supplier who understands that will refuse the term. The workable version names an independent inspector and the standard to be applied, agreed by both parties before the credit is opened.

And keep your remedies in the sale contract as well as in the credit. The credit governs payment; the contract governs what you were owed. If the two are inconsistent, the bank follows the credit — and the contract is the only place the goods themselves are described.