Letter of Credit Meaning: Issuance, Negotiation, and How to Avoid Discrepancies

Key takeaways

• A letter of credit is a bank undertaking to pay the exporter if the stipulated documents comply with the credit; banks deal in documents, not goods.
• The governing rules are the ICC’s UCP 600; if the credit sets no presentation period, documents must be presented within 21 calendar days after shipment and within expiry.
• Most discrepancies are found after shipment, so check the credit wording before loading and get amendments where needed.

A letter of credit (L/C) is a bank undertaking, opened at the importer’s request, to pay the exporter if the documents named in the credit comply with its terms. Banks look at documents, not goods. Whether the shipment turns into cash depends on the wording of the credit and on a complying presentation, not on a handshake in the contract.

The choice between telegraphic transfer and an L/C decides who carries the payment risk first. An L/C still earns its place on a first order, a large invoice, or a corridor where bank or country risk matters. It is a poor fit for small repeat orders, because opening charges and discrepancy costs can swallow the margin.

What a credit does, and what it does not

The working rule set is the ICC Uniform Customs and Practice for Documentary Credits, 2007 revision, ICC Publication No. 600, known as UCP 600. It has 39 articles. The ICC notes that most modern documentary credits are issued subject to it. Electronic presentation is covered by the eUCP supplement.

The credit does one job. If the required documents are presented on time and appear on their face to comply, the issuing bank must honour or negotiate as the credit states. It does not inspect quality, short shipment, or breach of the sales contract. Those sit in the sale contract and in any inspection clause. Delivery risk and cost sit in the Incoterms rule. The handover points are set out in the Incoterms 2020 summary.

Party	Role
Applicant	Usually the importer. Requests the credit and reimburses the bank
Issuing bank	Issues the credit and is bound if documents comply
Beneficiary	Usually the exporter. Presents documents and receives payment
Advising bank	Checks apparent authenticity and advises the credit
Confirming bank	Adds its own undertaking. Not present on every credit

Advice is not confirmation. An advised credit is the issuing bank’s promise. A confirmation adds the confirming bank’s promise. Exporters ask for confirmation when the issuing bank’s country is the risk they do not want to hold.

From issuance to payment

The operating sequence is short.

1. The sales contract states at sight or usance, and aligns required documents, latest shipment date, and expiry.
2. The importer asks its bank to issue. The bank checks limit and security, then issues.
3. The credit is often advised over SWIFT. The advising bank checks apparent authenticity and passes the credit to the beneficiary.
4. The exporter reads the credit before booking cargo. If goods description, quantity, ports, documents, partial shipments, transhipment, or the presentation period differ from the contract, the fix is an amendment before shipment.
5. After shipment, the commercial invoice, transport document, packing list, and any other required papers go in before expiry.
6. The nominated or issuing bank examines them. A complying sight credit is paid. A usance credit is accepted and paid at maturity. Negotiation is the nominated bank purchasing the draft or documents and advancing funds.

Under UCP 600, if the credit states no presentation period, documents must be presented within 21 calendar days after the date of shipment, and in any case no later than expiry. The examination period is a maximum of five banking days following the day of presentation. Those are ceilings in the rules, not a promise that every bank uses the full window.

A worked example: when usance cash actually arrives

Figures below are illustrative. They are not a market rate and not a won conversion.

Invoice USD 80,000. Shipment date 8 October. Credit terms: 60 days after shipment. Presentation period: 15 days after shipment. Expiry: 7 November.

• The presentation deadline is 23 October. The 15 days written in the credit override the 21-day default.
• If the bank receives complying documents on 20 October and accepts them, maturity is 7 December, 60 days after shipment.
• If the exporter asks for negotiation instead of waiting, and the discount is 6 percent a year for 48 days on a 360-day basis, the discount is about USD 80,000 × 0.06 × (48/360) = USD 640, before cable and handling charges. Day-count and rate follow the bank’s facility letter.

Sight payment removes that discount. It also pulls the importer’s cash need forward to just after shipment. Choosing the tenor is a working-capital decision, not only a fee comparison.

Mistakes that produce discrepancies

Most discrepancies are found after the vessel has sailed.

• The invoice description does not match the credit, even by one word. Align the contract wording with the credit before production, not after the bill of lading is issued.
• Shipment is later than the latest shipment date. A new sailing is not an amendment.
• Extra documents are attached and then contradict the required set. Present what the credit asks for.
• The credit prohibits transhipment, but the routing tranships. Check the sailing schedule with the forwarder against the credit.
• The origin certificate is the wrong form for the preference scheme. Issuing authority versus self-certification is separated in the certificate of origin guide.
• Expiry and the presentation period are treated as the same date. The earlier of the two is the real deadline.

A discrepancy lets the bank refuse. The applicant may waive it, but a waiver is the applicant’s choice, not the bank’s duty. Confirmation does not cure a bad presentation.

Summary

A letter of credit is a conditional bank undertaking, and the condition is complying documents. The rule book is the ICC’s UCP 600. Split the roles of applicant, issuing bank, beneficiary, advising bank, and confirming bank. Amend the credit before shipment. Treat the earlier of expiry and the presentation period as the deadline. Whether cash arrives at sight, at maturity, or after a negotiation discount should be agreed, with the fee quote, before the credit is opened.

The ICC Academy note on documentary credits is the official primer: https://academy.iccwbo.org/international-trade/article/documentary-credits-rules-guidelines-terminology/

FAQ

What does the bank check under a letter of credit?

Only whether the documents comply on their face with the credit’s terms. It does not inspect quality, shortages or breaches of the sales contract.

What is the difference between an advising bank and a confirming bank?

The advising bank checks the credit’s apparent authenticity and passes it on. A confirming bank adds its own payment undertaking to the issuing bank’s.

What is the deadline for presenting documents?

If the credit is silent, 21 calendar days after the shipment date, and never later than expiry. Whichever comes first is the real deadline.

What happens if documents are discrepant?

The bank may refuse to pay. The applicant can waive the discrepancies, but that is the applicant’s choice, not a bank obligation.

Related: Bill of lading vs sea waybill, Incoterms 2020 summary, Certificate of origin guide