Letter of Credit - The Complete Guide

What is a Letter of Credit?

A Letter of Credit (LC) is a written promise from a bank to pay the seller (exporter) a fixed amount of money, but only if the seller presents the exact documents listed in the Letter of Credit.

In simple terms:

• The buyer's bank takes the risk of payment instead of the buyer.
• The seller gets paid only when the correct shipping and commercial documents are presented.
• The rules that almost all banks follow are called UCP 600 (issued by the International Chamber of Commerce).

An LC is commonly used when the buyer and seller do not know each other well, or when the transaction value is high.

Most Common Reasons Banks Refuse Payment (Discrepancies)

Here are the problems that most often cause banks to reject documents under a Letter of Credit:

Who does what in an LC

• Applicant - the buyer/importer who asks its bank to issue the LC.
• Issuing bank - the applicant's bank; issues the LC via SWIFT MT700 and pays a complying presentation.
• Advising bank - the bank in the beneficiary's country that authenticates and advises the credit.
• Confirming bank - optional; adds its own undertaking to pay. Used when the issuing bank or country risk is weak.
• Nominated / negotiating bank - the bank authorised to accept and pay against documents.
• Beneficiary - the exporter/seller who ships and presents documents.

Sight vs usance

A sight LC pays the beneficiary upon presentation of complying documents (UCP 600 Art. 6(b)). A usance (or deferred payment) LC pays a fixed number of days after presentation, shipment or acceptance - commonly 30, 60, 90 or 180 days. The beneficiary bears the time-value cost, which is why usance LCs are often discounted with the nominated bank.

Usance interest is computed using per-currency day-count conventions: ACT/360 for USD, EUR, JPY, CHF and AED; and ACT/365 for GBP, INR and most Commonwealth currencies. The convention alone can move a 90-day discount by 1.4% - enough to swing a marginal deal.

What Does a Letter of Credit Actually Cost?

The cost of an LC is not just one fee. Several parties can charge fees. Here is a clear breakdown:

Understanding the SWIFT MT700 – Field by Field Guide

When a bank issues a Letter of Credit, it sends a standard electronic message called MT700. Below is a plain-language explanation of the most important fields, what you must check before the LC is issued, and what you must check when preparing shipping documents.

Field 40A – Form of Documentary Credit

• Meaning: Says whether the LC is Irrevocable and whether it is Transferable.
• Before issuing: Almost always choose "Irrevocable". Avoid "Revocable".
• When preparing documents: No action needed. Just be aware if the LC is transferable.

Field 31D – Date and Place of Expiry

• Meaning: The last date and the place where documents must be presented.
• Before issuing: Give the seller enough time (usually 21 days after shipment is reasonable).
• When preparing documents: Present documents before this date. Late presentation is one of the most common reasons for rejection.

Field 32B – Currency Code and Amount

• Meaning: The exact currency and maximum amount of the LC.
• Before issuing: Make sure the amount covers the full order value plus any allowed tolerance.
• When preparing documents: The invoice must not exceed this amount (unless a tolerance is allowed in Field 39A).

Field 39A – Percentage Credit Amount Tolerance

• Meaning: How much the invoice can be higher or lower than the LC amount (for example 10/10 means ±10%).
• Before issuing: Decide if you want to allow a tolerance (common for bulk commodities).
• When preparing documents: Stay within the allowed tolerance.

Field 41A / 41D – Available With… By…

• Meaning: Which bank can handle the documents and how payment will be made (by payment, by acceptance, by negotiation, etc.).
• Before issuing: Decide whether you want the LC available with any bank or only with a specific bank.
• When preparing documents: Present the documents to the correct bank mentioned here.

Field 42C – Drafts at…

• Meaning: If usance (deferred payment) is allowed, this shows after how many days payment will be made (for example "90 days after sight").
• Before issuing: Agree the payment terms (sight or usance) with the seller.
• When preparing documents: Make sure the draft (bill of exchange), if required, matches this wording exactly.

Field 43P – Partial Shipments

• Meaning: Whether the seller is allowed to ship the goods in more than one lot.
• Before issuing: Decide if partial shipments are acceptable.
• When preparing documents: Follow the instruction. If "Not Allowed", you must ship everything together.

Field 43T – Transshipment

• Meaning: Whether the goods can be transferred from one ship/aircraft to another during the journey.
• Before issuing: Decide based on the shipping route.
• When preparing documents: Make sure the Bill of Lading matches what the LC allows.

Field 44A / 44E / 44F / 44B – Place of Taking in Charge / Port of Loading / Port of Discharge / Place of Final Destination

• Meaning: The shipping route.
• Before issuing: Write the correct ports or places. Avoid vague terms.
• When preparing documents: The Bill of Lading must show exactly these places (or places within the same range if allowed).

Field 44C – Latest Date of Shipment

• Meaning: The last date the goods can be shipped.
• Before issuing: Give a realistic date that the seller can meet.
• When preparing documents: The "On Board" date on the Bill of Lading must be on or before this date.

Field 45A – Description of Goods and/or Services

• Meaning: The exact description of the goods.
• Before issuing: Write a clear but not overly detailed description. Avoid unnecessary technical specifications that can cause mismatches.
• When preparing documents: The commercial invoice must use the same description (or a description that is not in conflict). This is one of the biggest sources of discrepancies.

Field 46A – Documents Required

• Meaning: The full list of documents the seller must present to get paid.
• Before issuing: List only the documents you really need. Every extra document increases the chance of a discrepancy.
• When preparing documents: Prepare every single document listed here. Missing even one document can cause rejection.

Field 47A – Additional Conditions

• Meaning: Extra rules and special conditions.
• Before issuing: Keep this field as short and clear as possible. Many unnecessary conditions are written here.
• When preparing documents: Read every condition carefully and follow them exactly.

Field 48 – Period for Presentation

• Meaning: How many days after shipment the seller has to present the documents (commonly 21 days).
• Before issuing: 21 days is standard. Shorter periods can be difficult for the seller.
• When preparing documents: Present documents within this number of days after the shipment date.

Field 49 – Confirmation Instructions

• Meaning: Whether the LC should be confirmed by another bank.
• Before issuing: Choose "Without", "Confirm", or "May add".
• When preparing documents: No direct action, but confirmation gives the seller extra safety.

Field 71B – Charges

• Meaning: Who pays the bank charges.
• Before issuing: Clearly state which charges are for the buyer's account and which are for the seller's account.
• When preparing documents: Be aware of which fees will be deducted from the payment.

Practical Advice Before Issuing an LC

• Give the seller enough time for production + shipping + document preparation.
• Avoid over-detailed goods descriptions in Field 45A.
• Only ask for documents you truly need in Field 46A.
• Make sure the latest shipment date and presentation period are realistic.

Practical Advice When Preparing Shipping Documents

• Always start by printing the full LC and highlighting Fields 45A, 46A, 44C, 31D and 48.
• Make a checklist from Field 46A and tick off every document.
• Make sure the goods description on the invoice matches Field 45A as closely as possible.
• Ensure the Bill of Lading is "clean" and "on board" with the correct date and ports.

Standby LC vs commercial LC

A standby LC (SBLC) is a payment-of-last-resort instrument that only pays on the beneficiary's demand for non-performance. Commercial LCs pay on a complying presentation of shipping documents. SBLCs can be issued under UCP 600, ISP98 (the ICC's rule set specific to standbys) or URDG 758 (demand guarantees). Choose ISP98 for pure financial obligations, URDG for performance obligations, UCP 600 where the counterparty prefers documentary-credit mechanics.

Fraud red flags

These wording patterns are almost always fraudulent - treat as prima facie evidence and walk away:

• "Prime bank instrument", "leased SBLC", "fresh cut", "MT760 blocked funds", "tested telex", "Full Bank Responsibility (FBR)". None of these are recognised under UCP or SWIFT.
• A soft offer chain demanding NCNDA/IMFPA signatures before product details, or ICPO before LOI. Classic advance-fee fraud setup.
• Prices materially below Platts/Argus. If a crude offer sits 20% below the daily assessment, it is fraud, sanction evasion or both.
• POF / BCL from unknown private banks. Verify SWIFT BIC and correspondent banking relationships.

Practical workflow - using this site's calculators

1. Model total cost with the LC Cost Calculator. Vary confirmation on/off, tenor and currency. Charges use the correct ACT/360 vs ACT/365 basis for the LC currency.
2. If usance, compute the discount and net proceeds with the Usance Interest Calculator.
3. Check your documents with the LC Discrepancy Scanner before presentation.
4. For standby / performance guarantees, use the SBLC / Bank Guarantee Fee Estimator.

This guide is decision-support, not banking advice. Always confirm LC terms with your bank, and refer to the current UCP 600 / ISBP 821 texts published by the ICC.