Letter of Credit - The Complete Guide

A Letter of Credit (LC) is a bank's conditional promise to pay a beneficiary a specific amount against the presentation of documents that comply with the credit's terms. It replaces the exporter's credit risk on the buyer with the credit risk of a bank - usually one they can price and hedge.

Every commercial LC in the world is issued under the ICC's Uniform Customs and Practice for Documentary Credits, 2007 Revision (UCP 600). UCP 600's 39 articles govern how banks examine documents, when payment falls due, what a complying presentation looks like, and how discrepancies are handled. The companion practice guide, ISBP 745 (2013), translates those articles into line-level examination rules.

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 an LC actually costs

The headline "0.125% per quarter" is only part of the picture. A typical confirmed sight LC breaks down as:

• Issuance - 0.125–0.25% of the credit amount per quarter of validity (issuing bank).
• Confirmation - 0.15–0.4% per quarter (confirming bank), scaled to issuing-bank/country risk.
• Advising - flat USD 75–150.
• Negotiation / payment - 0.1–0.2% of the drawing amount.
• Reimbursement - flat USD 100–300 (issuing bank to reimbursing bank).
• Courier & SWIFT - USD 50–150 per set.
• Discrepancy fee - USD 75–150 per discrepant presentation (charged even if documents are eventually accepted).

SWIFT Field 71B allocates who pays which charges. Common patterns: "All charges outside the issuing bank for beneficiary account" (the exporter absorbs confirmation and negotiation); "All charges for applicant"; or a bespoke split. Confirm 71B matches your commercial agreement - post-issuance changes require an amendment.

Discrepancies - the number one cost driver

Estimates from ICC banking commission surveys put first-presentation discrepancy rates at 60–80% globally. Under UCP 600 Art. 14, banks have a maximum of 5 banking days to examine a presentation; a discrepant one can be rejected outright. The most common discrepancies:

1. Late shipment vs latest shipment date in LC.
2. Credit expired at time of presentation.
3. Description of goods in commercial invoice inconsistent with LC (a common cure: echo Field 45A verbatim).
4. Transport document dated after latest shipment, or not marked on-board.
5. Weight, quantity or unit price outside stated tolerance.
6. Missing signature, endorsement or notary.
7. Insurance cover below required minimum (110% of CIF).

Under UCP 600 Art. 30, "about" and "approximately" allow a ±10% tolerance on the credit amount and quantity. A separate ±5% quantity tolerance applies where the quantity is not stated in packing units or individual items - and only if the total drawing does not exceed the credit amount.

Reading a SWIFT MT700

The operative terms of an LC live in MT700 fields. The critical ones:

• 40A - Form of documentary credit (irrevocable/transferable).
• 31D - Date and place of expiry.
• 32B - Currency and amount.
• 39A/39B/39C - Percentage credit amount tolerance, maximum credit amount, additional amounts covered.
• 41A/41D - Available with … by …
• 42C/42P - Drafts at … / Deferred payment details.
• 43P/43T - Partial shipments, transhipment.
• 44A–F - Place of receipt, loading, discharge, final destination, latest shipment date, shipment period.
• 45A - Description of goods and Incoterm.
• 46A - Documents required (the highest-risk field).
• 47A - Additional conditions.
• 71B - Charges.
• 78 - Instructions to paying/accepting/ negotiating bank.

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. Before issuance, run the draft through the LC Application Checklist. It scores against every ISBP 745 rule and flags UCP 600 Art. 14 / 20 / 30 concerns.
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 745 texts published by the ICC.