A Letter of Credit (LC) is one of the most trusted instruments in international trade, providing security to both exporters and importers. But to use it effectively, it’s important to understand how an LC moves through its lifecycle , from the initial agreement to the final settlement of payment.
This process is carefully structured under the UCP 600 rules issued by the International Chamber of Commerce (ICC) and moves and managed electronically through the SWIFT network (typically via MT700 messages).
Let’s walk through the key stages.
- The Sales Agreement
The LC process begins with a sales contract between the buyer (importer) and the seller (exporter).
The contract specifies payment the bank pays by Letter of Credit and outlines the key commercial terms:
- Goods or services being sold
- Price, quantity, and delivery terms
- Required shipping documents
- Delivery and payment timelines
It is essential the contract terms align with what will be reflected in the LC later.
- LC Application and Issuance
Once the sales contract is signed, the buyer applies to their bank (the issuing bank) for a Letter of Credit in favour of the seller.
The issuing bank assesses the buyer’s creditworthiness and may require collateral or security before issuing the LC.
The LC is then transmitted electronically to the seller’s bank (the advising bank) via the SWIFT MT700 message format, which makes sure a secure, standardised communication between institutions.
- Advising and Review
The advising bank receives the LC, authenticates it, and notifies the seller.
The exporter must carefully review the LC to ensure all terms and conditions are consistent with the sales contract and practical to fulfil.
If any discrepancies or unrealistic conditions are found, the exporter must request an amendment , sent via a SWIFT MT707 message.
- Shipment and Documentation
Once the LC terms are confirmed, the exporter ships the goods as agreed and prepares the required documents, such as:
- Commercial Invoice
- Bill of Lading or Air Waybill
- Packing List
- Insurance Certificate
- Certificate of Origin
- Inspection or Quality Certificate
These documents serve as evidence the exporter has fulfilled their obligations under the LC.
- Presentation of Documents
The exporter submits the completed documents to their nominated or presenting bank within the LC’s time limits.
The bank examines the documents in accordance with UCP 600 Articles 14-17, ensuring they comply strictly with the LC terms.
- Examination and Payment
If the documents are compliant, the issuing or confirming bank honours the payment obligation:
- Sight LC: Payment is made immediately.
- Usance (Deferred) LC: Payment is made at a specified future date.
If discrepancies are found, the bank follows UCP 600 Article 16 procedures , notifying the presenter within five banking days and awaiting instructions from the buyer.
- Reimbursement and Settlement
Once the issuing bank pays or accepts payment responsibility, it seeks reimbursement from the buyer (the applicant).
In confirmed LCs, if the confirming bank has already paid the exporter, it will then claim reimbursement from the issuing bank.
This step closes the transaction, completing the LC’s lifecycle.
- Archiving and Audit
Finally, all parties retain the documents and SWIFT message records for audit and compliance purposes.
This documentation gives an evidential trail , essential for dispute resolution, regulatory review, and financial record-keeping.
Why the Lifecycle Matters
Understanding each step of the LC process helps exporters and importers:
- Prevent delays and costly errors
- Identify potential risks early
- Ensure compliance with UCP 600
- Build smoother, more reliable trade relationships
Final Thoughts
A Letter of Credit is more than a payment guarantee , it’s a structured, rule-based process designed to facilitate trust in global commerce.
From issuance through to settlement, every step is supported by international standards:
- UCP 600 gives the regulatory framework.
- SWIFT MT700 messaging makes sure secure global communication.
- and bank examination procedures safeguard fairness and transparency.
Mastering the LC lifecycle enables businesses to trade with confidence , knowing every document, deadline, and payment follows by precision and international best practice.
