Bennisha

Expert

Published on: Sep 25, 2026

Letter of Credit (LC)

A Letter of Credit (LC) is a crucial financial document that guarantees the buyer’s payment to the seller, providing assurance in trade transactions. It is widely used by businesses to facilitate secure international trade. Issued by a bank, it ensures full and timely payment to the seller. If the buyer cannot make the payment, the bank covers the full or remaining amount on their behalf, minimizing risks in international trade for both parties. In this article, we delve into the basics of Letter of Credit transactions and the various types of LCs.

What is a Letter of Credit?

LC stands for Letter of Credit, a financial instrument commonly utilized in global trade to secure payment for transactions. LCs serve as a bank’s guarantee that a seller will receive payment from a buyer, provided all agreed terms and conditions are met. This risk mitigation tool supports smooth trade operations and boosts confidence in cross-border deals. Typically, an LC can be issued against pledged securities or cash, with banks charging a fee, generally calculated as a percentage of the LC’s total size.

Basics of a Letter of Credit Transaction

Applicant: The buyer or importer of goods. The applicant must make the payment if documents, as per the LC’s conditions, are presented to the bank.

Beneficiary: The seller or exporter to whom the LC is addressed. Payment is received from the nominated bank upon submission of the documents per the LC conditions.

Issuing Bank: The buyer's bank, providing its guarantee to the transaction. It becomes liable for payment once documents are received as per the LC conditions from the negotiating bank.

Negotiating Bank: The seller's bank, which claims payment from the issuing bank.

Importance of Letters of Credit

Required for international trade, assuring the buyer only pays once the seller provides proof of shipment.
Prevents unnecessary advance payments by the buyer.
Facilitates international business expansion.
Helps secure funding for business operations.
Used to verify the creditworthiness of a corporation or individual.
Provides a safety net for buyers unable to make payments.

Advantages of Letters of Credit

Enhances the ability to explore new overseas markets.
Fosters new global business connections.
Highly customizable terms catering to specific business needs.
Allows continuity in business terms with existing partners in multiple deals.

Parties to Documentary Credit

Commercial parties: Buyers, sellers, applicants, beneficiaries.
Banking entities: Issuing banks, advising banks, confirming banks, reimbursing banks.
Related participants: Shipping lines, insurance companies, forwarders.

Types of a Letter of Credit

Letters of credit can be categorized as follows:

Sight Credit

Payment is made immediately upon presentation of the correct documentation. For example, with a sight letter of credit, a businessman can obtain necessary funds instantly by presenting a bill of exchange to a lender.

Acceptance Credit/ Time Credit

Usance bills, payable after a period, are accepted and honored upon their due dates under this type of credit.

Revocable Letter of Credit

This type allows the issuing bank to revoke the LC without the beneficiary's consent.

Irrevocable Letter of Credit

An irrevocable LC cannot be changed or canceled without the consent of all parties involved. It's a reliable choice for assuring payment realization.

Confirmed Letter of Credit

The advising bank adds a guarantee of payment, similar to the issuing bank, ensuring the payment is honored when due. This provides more security to the beneficiary.

Back-to-Back Letter of Credit

This involves the opening of a second LC, by the initial beneficiary, in favor of a second beneficiary. Typically, it facilitates arrangements for suppliers.

Transferable Letter of Credit

Permits the initial beneficiary to transfer the credit to another party, usually a supplier, although further transfers are not allowed.

Restricted Letter of Credit

Designates a specific bank to handle payments or negotiate credit transactions.

Revolving Letter of Credit

Allows repeated use of the LC facility against subsequent transactions, based on previous drawings and payments.

Precautions to be Taken

The granting bank should be the applicant's regular banker, familiar to both opener and beneficiary, ensuring the security and authenticity of transactions.

Foreign LCs should preferably be advised through an Indian bank and, where possible, confirmed to ensure security.
Clarify bank charges responsibilities upfront to prevent disputes; typically, each party handles charges in their country, including confirmation charges.
Verify whether freight is prepaid according to contract terms, ensuring clarity in transaction details.

Import Export Code

The Import Export Code (IEC) is integral for starting import-export operations, serving as a key compliance requirement in global trade. Obtaining an IEC unlocks various benefits conducive for business growth. You can apply for an Import Export Code through IndiaFilings and expect issuance within 6 to 7 days.

Explore our resources for more information about specific Letter of Credit schemes and detailed insights into the business loan implications of Letters of Credit.

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Frequently Asked Questions

Common questions about Letter of Credit Services for International Trade.

A Letter of Credit (LC) is a document issued by a bank that guarantees the payment to the seller by the buyer in a trade transaction. It serves as a secure payment method for international trade, reducing risks for both parties involved.

The key parties involved in an LC transaction are the applicant (buyer/importer), beneficiary (seller/exporter), issuing bank (buyer's bank), and negotiating bank (seller's bank).

A revocable Letter of Credit can be revoked or canceled by the issuing bank without the beneficiary's consent, while an irrevocable Letter of Credit cannot be revoked or amended without the beneficiary's agreement.

A confirmed Letter of Credit is one where the advising bank, at the request of the issuing bank, adds its confirmation that payment will be made. This provides additional security to the beneficiary.

A back-to-back Letter of Credit is when the original beneficiary opens a second LC in favor of another beneficiary (usually a supplier) against the security of the original LC.

Letters of Credit are crucial in international trade as they provide payment security for both buyers and sellers, mitigating risks and facilitating smooth trade operations across borders.

Some advantages of using a Letter of Credit include establishing new business connections globally, customizing terms and conditions, and providing a secure payment method for international trade transactions.

A transferable Letter of Credit is one where the beneficiary can transfer the LC, in whole or in part, to a second beneficiary, typically a supplier to the seller.

A revolving Letter of Credit allows the applicant to use the LC facility again based on drawings and payments made against previous LCs, providing a renewable credit line.

Some precautions include checking bank charges, ensuring the LC is advised through a known Indian bank, confirming the expenses to be borne by each party, and verifying the freight terms as per the contract.