Capital & Financing

Letters of Credit

The instrument that lets two strangers on opposite sides of the world trade safely — and the one thing it will never protect you from.

  • Intermediate
  • 8 min total
  • 12 chapters

What decision this helps you make: Whether a shipment should be paid by letter of credit rather than a deposit, open account, or escrow — and, if so, exactly what the credit must say.

What this topic is

A letter of credit is a bank's written promise to pay a seller a stated amount if the seller hands over a stated set of documents by a stated deadline. The bank replaces the buyer's credit with its own. It checks paperwork, not cargo.

Why it matters

It is how a first-time importer buys $400K of goods from a factory that has never heard of them, and how the factory ships without wondering if it will ever be paid. Get the terms wrong and you pay a bank fee for protection you do not have.

Who should learn it

Importers, exporters, and anyone signing a large cross-border purchase where neither side is willing to go first.

What you will understand

  • What a letter of credit actually promises — and what it does not
  • The document chain, the deadlines, and how a bank decides to pay
  • Why most first presentations get rejected, and how to prevent it
  • When a letter of credit is the wrong tool and something cheaper wins

Prerequisites

Common misconception

"A letter of credit guarantees I get the goods I paid for." It does not. Under the rules nearly every credit is issued under, banks deal in documents and never in goods. If the paperwork matches the credit, the bank pays — even if the container is full of scrap. A letter of credit protects against non-payment and non-shipment-of-documents. Protection against bad goods has to be bought separately, by naming an independent inspection certificate as one of the required documents.