International trade involves trust and when buyers and sellers are thousands of miles apart, trust alone isn’t always enough. Different currencies, legal systems, and business practices can make payment and delivery risky for both sides.
That’s where a Letter of Credit (LC) comes in.
What is a Letter of Credit?
A Letter of Credit is a written commitment from a bank, made on behalf of a buyer (the importer), to pay a seller (the exporter) a specified amount provided that the seller presents documents proving that the goods have been shipped as agreed.
In other words, the bank guarantees payment, but only when the seller meets the agreed terms and provides the correct paperwork.
How It Works
- Agreement: The buyer and seller agree to trade under LC terms.
- Issuance: The buyer asks their bank (the issuing bank) to issue a Letter of Credit in favour of the seller.
- Transmission: The LC is sent electronically to the seller’s bank (the advising bank) via the SWIFT messaging network, usually using one or more MT700 messages.
- Shipment & Documents: The seller ships the goods and submits the required documents (such as the bill of lading, commercial invoice, and insurance certificate).
- Examination & Payment: The bank reviews the documents. If they comply with the LC’s terms, payment is made to the seller either immediately (sight LC) or at a later date (usance/deferred LC).
The Rules: UCP 600
Letters of Credit are governed internationally by a set of rules known as UCP 600 short for Uniform Customs and Practice for Documentary Credits, Publication No. 600, issued by the International Chamber of Commerce (ICC).
UCP 600 provides a standard framework that banks and traders around the world follow. It defines key terms, sets out how documents must be presented, and outlines the responsibilities of each party.
This ensures that whether a trade is between London and Lagos, or Dubai and Dublin, everyone is operating under the same trusted principles.
Why Use a Letter of Credit?
- For Exporters: It reduces the risk of non-payment because the bank stands behind the buyer.
- For Importers: It ensures payment is only made once the seller meets all agreed conditions.
- For Both Parties: It builds confidence in cross-border trade and enables smoother, faster transactions.
Final Thoughts
Letters of Credit may seem technical, but they’re an essential foundation of global trade. Backed by the UCP 600 rules and transmitted securely through SWIFT MT700 messages, they offer structure, security, and trust in an otherwise uncertain environment.
