A letter of credit (LC), also called a documentary credit, is a written undertaking by a bank to pay a seller (the beneficiary) a fixed sum once the seller presents documents that exactly match the terms of the credit. It moves the payment risk away from the buyer and onto the buyer's bank, which is why LCs remain the backbone of cross-border trade between parties who may never have dealt with each other before.
How a letter of credit works
The buyer (applicant) asks its bank, the issuing bank, to open an LC in favour of the seller. The issuing bank transmits it, usually over the SWIFT MT700 message, to a bank in the seller's country, which advises or confirms the credit. The seller ships the goods, assembles the documents the LC calls for such as the commercial invoice, bill of lading, marine insurance, certificate of origin and inspection certificate, and presents them to the bank. If the documents comply, the bank pays; the buyer then reimburses its bank and collects the documents to clear the consignment. The governing principle is that banks deal in documents, not goods. They never inspect the cargo, only the paperwork.
Common types of LC
| Type | What it does |
|---|---|
| Irrevocable | Cannot be amended or cancelled without every party's consent. Under UCP 600 every credit is irrevocable by default, so revocable LCs are effectively obsolete. |
| Confirmed | A second bank, usually in the seller's country, adds its own guarantee on top of the issuing bank's, covering issuing-bank and country risk. |
| Transferable | The beneficiary can transfer all or part of the credit to a third party, useful for agents and intermediaries. |
| Standby (SBLC) | A payment guarantee of last resort, invoked only if the buyer defaults. It functions much like a bank guarantee. |
Other variants include revolving LCs for repeat shipments, back-to-back LCs for intermediary trade and red-clause LCs that release an advance to the seller.
Strict documentary compliance
Payment turns entirely on the documents. Under UCP 600 the bank has a maximum of five banking days after presentation to examine them and decide, and documents must be presented within 21 calendar days of shipment (unless the LC says otherwise) and before the expiry date. Even minor discrepancies, a misspelt consignee name, a late shipment, an expired credit or drawing over the LC value, let the bank refuse to pay. Bankers apply the ICC's International Standard Banking Practice (ISBP) when checking, so getting the documents right the first time is what actually secures your money.
The rules that apply in India
Globally, most LCs are issued subject to the ICC's UCP 600 (2007 revision), still the current rulebook in 2026, with the eUCP supplement covering electronic presentations. For Indian importers, an LC also sits under the Foreign Exchange Management Act, 1999 (FEMA) and the RBI's framework, including the Master Circular on Guarantees and Co-acceptances. After the 2018 Punjab National Bank fraud, the RBI discontinued Letters of Undertaking (LoUs) and Letters of Comfort for trade credit, but letters of credit and bank guarantees remain fully permitted, subject to due diligence. Bank commission and charges on an LC attract GST at 18%.
Practical tips
- Review the LC line by line the day you receive it and secure any amendment before you ship, not after.
- Match every document word-for-word to the LC wording, including names, quantities and Incoterms.
- Track the expiry date and presentation period closely; a late presentation is the most common reason payment is withheld.
- For a new or high-risk counterparty, ask for a confirmed irrevocable LC so a bank in India stands behind the payment.