By ARIA June 3, 2020 In Uncategorized

Documentary Credits Series: Letters of Credit

What is a letter of credit?

In its simplest form a letter of credit is a document issued by a bank guaranteeing a seller payment. Provided that its terms are met, the bank guarantees that the seller will receive payment. Letters of credit are used extensively in international trade and are essential


Letters of credit have existed in many different forms for centuries. However, the first codification of Uniform Customs and Practice (UCP) for Documentary credits was overseen by the International Chamber of Commerce (ICC) in 1933. Since the mid 1970’s the majority of letters of credit have been issued in electronic form. The most recent iteration of UCP for documentary credits to be promulgated by the ICC is UCP600 (2007 revision), which govern the majority of documentary credits issued.

How they work

Letters of credit help mitigate sellers’ risk by ensuring that the seller is paid on time. Provided that the documents stipulated in the underlying contracts are presented, the seller (who may not know the buyer) can be sure of being paid as the seller looks to the bank as opposed to the buyer for payment.

Once the documents have been presented to the banks the bank has control over the goods which secures payment by the buyer on whose behalf the bank has issued the letter of credit.

Once the issuing bank is satisfied as to the buyer’s ability to pay for the goods, it will issue a letter of credit in favour of the seller. The seller will satisfy itself that the letter of credit matches the underlying contract terms, before arranging for the goods to be shipped. Once shipment has taken place the seller presents the requested documents to the nominated bank. The bank will only pay the seller in respect of the goods when the seller provides the bank with documents which comply strictly with the contract.

Once the documents have been presented to the banks the bank has control over the goods which secures payment by the buyer on whose behalf the bank has issued the letter of credit.

Types of Letter of Credit:

  • Revocable/Irrevocable Letter of Credit — Whether a letter of credit is irrevocable or revocable is determined by whether the buyer and issuing bank are able to amend and alter the Letter of credit without the seller’s permission. According to UCP 600, all letters of credit are irrevocable. In this way, the number of revocable letters of credit is becoming increasingly obsolete. Any changes or amendments to the contract must be undertaken through the buyer and issuing bank and approved by the seller
  • Confirmed/Unconfirmed Letter of Credit — A letter of credit is considered to be confirmed when a second bank adds its confirmation (guarantees) that it will honour a complying presentation at the request of the issuing bank. A complying presentation is a set of documents that meet with the requirements of the letter of credit and all of related rules.
  • Deferred / Usance Letter of Credit — Is a credit that is not paid or assigned immediately after the presentation, but instead after an indicated period that is accepted by both buyer and seller.
  • Standby Letters of Credit — As opposed to operating as the primary payment mechanism (cash against documents) a “Standby Letter of Credit” operates in the case of non performance of the contract. If the buyer does not perform for any reason, then the Seller can draw upon the SBLC as a last resort.

Why they’re used

Letters of credit are essential to the efficient operation of International trade and have multiple advantages for both the buyer and the seller. The principal benefits for the seller include certainly of on time payment in full against the presentation of documents. The principal benefits for the buyer include being able to determine the time –window for shipment of the underlying cargo and being able to reduce or avoid have to make advance payment.