What Is a Letter of Credit (L/C)?

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mekong

December 25, 2025 On December 24, 2025

In international trade, payment risk is one of the biggest concerns for importers. When goods are produced overseas, shipped across borders, and governed by different legal systems, a simple bank transfer may feel unsafe especially for large or first-time orders. This is where the Letter of Credit (L/C) comes in. An L/C is often described as the “most secure” payment method in global trade. In reality, it is a highly structured, document-based payment tool that offers protection in specific situations—but also introduces cost, delay, and complexity. This article explains what an L/C is, how it works, what it really protects, and when importers should (and should not) use it.

What Is a Letter of Credit (L/C)?

A Letter of Credit (L/C) is a bank-issued payment guarantee. It is a written commitment by the importer’s bank to pay the exporter only if the exporter presents a set of documents that strictly comply with the L/C terms. The bank does not guarantee the goods. The bank guarantees payment against documents.

In an L/C transaction:

The importer applies for the L/C
The bank controls payment
The supplier is paid only when documents match exactly

How an L/C Works Step by Step

The L/C process follows a strict and structured sequence. Each step is governed by bank procedures and deadlines. Payment depends entirely on whether documents comply with the L/C terms. Even small deviations can stop payment. This structure explains both the strength and the risk of using an L/C.

Importer and supplier agree to use L/C as payment
Importer applies to their bank to open the L/C
Bank issues the L/C with detailed conditions
L/C is sent to the supplier’s bank
Supplier manufactures and ships the goods
Supplier submits required documents to the bank
Banks review documents line by line
If documents comply, payment is released
If documents do not comply, payment is delayed or rejected

The entire system is document-driven.

Key Parties in an L/C Transaction

An L/C involves multiple parties, each with a defined role. The importer requests the credit, while banks act as intermediaries and controllers. The supplier becomes the beneficiary of the bank’s promise, not the importer’s. Because banks deal only with documents, their role is limited in scope. Knowing who controls what prevents false expectations.

Applicant: Importer (buyer)
Issuing Bank: Importer’s bank
Beneficiary: Exporter (supplier)
Advising Bank: Supplier’s bank
Confirming Bank (optional): Adds extra guarantee

Each party focuses on documents, not physical goods.

What an L/C Actually Protects

An L/C protects payment conditions, not commercial outcomes. It ensures that the supplier is paid only after submitting compliant shipping documents. It does not verify product quality, timing, or usability. Many importers misunderstand this point and overestimate L/C security. Clarity here prevents costly mistakes.

Risks Mitigated by an L/C

Supplier does not get paid without shipping documents
Payment is handled by banks, not trust alone
Useful for very large or high-risk transactions

Risks NOT Covered by an L/C

Product quality
Wrong materials or sizing
Poor workmanship
Late delivery caused by production issues

Banks do not inspect factories or goods.

The Biggest Risk of Using L/C: Document Discrepancies

Document discrepancies are the most common cause of L/C failure. Banks require exact matches between documents and L/C wording. Even minor typographical errors can delay or block payment. These issues arise even when goods are correct and on time. This risk is inherent to the L/C system. The most common L/C failure is document discrepancy.

Examples:

Typo in company name
“Cartons” vs “boxes”
Date mismatch
Slight difference in product description
Late presentation of documents

Even if goods are perfect, payment can be blocked. This risk is structural, not accidental.

Cost of Using an L/C

L/Cs carry significantly higher costs than direct payment methods. Fees are often percentage-based and accumulate quickly. Amendments and discrepancies add unexpected expenses. For medium-sized orders, these costs can erode profit margins. Importers must calculate total cost before committing.

Direct Bank Fees

Opening fee (0.1%–1% of value)
Advising fee
Amendment fee
Discrepancy fee
Confirmation fee (if required)

Total Cost

Commonly 1%–3% of order value
On a $100,000 order: $1,000–$3,000+

Hidden Costs

Staff time
Consultant fees
Shipment delays
Demurrage and storage

Time Impact of an L/C

An L/C adds multiple layers of time to a transaction. Issuance, document preparation, and bank review all create delays. Amendments further extend timelines. In fast-moving industries, this lost time can outweigh any perceived security. Time impact is often underestimated.

An L/C adds weeks to the payment cycle:

Issuance: 1–2 weeks
Document preparation: several days
Bank review: up to 7 days
Amendments: additional delays

In seasonal industries like apparel, time loss equals sales loss.

When Should Importers Use an L/C?

An L/C is best suited for specific, high-risk scenarios. These include very large orders, new suppliers, or bank-financed transactions. It is less effective for custom or repeat orders. Using L/C by default creates unnecessary friction. Strategic selection is essential.

An L/C is appropriate when:

Order value is exceptionally high
Supplier is new and high-risk
Legal enforcement is weak
Required by bank financing or investors
Trading standardized commodities

It is not ideal for:

Custom apparel
Frequent repeat orders
Time-sensitive goods
Small or mid-size businesses

Best Practices for Importers Using L/C

Successful L/C use requires precision and discipline. Clear wording, limited documents, and realistic timelines reduce risk. Importers must review every clause before issuance. Active monitoring is required throughout the transaction. Without control, L/C increases complexity instead of safety.

L/C Control Checklist:

Verify supplier legal name exactly
Confirm bank details independently
Keep wording simple and objective
Match Proforma Invoice exactly
Limit required documents
Set realistic shipment and expiry dates
Review draft L/C line by line
Plan amendments early
Act fast on document review
Track total L/C cost after completion

Discipline is mandatory. Without it, L/C increases risk.

Conclusion / Final Words

A Letter of Credit (L/C) is not a universal safety tool. It is a specialized banking instrument designed to control payment through document compliance. For importers: