Letter of credit

Use a bank's documentary payment undertaking to bridge buyer and seller performance risk while controlling the required documents, dates and funding exposure.

Quick answer

A commercial letter of credit is a bank undertaking issued at an applicant's request in favour of a beneficiary, under which the bank honours a complying presentation of specified documents. The credit is separate from the underlying sale contract, and banks examine documents rather than the goods, services or performance they represent. The credit should define amount, availability, expiry, presentation period, required documents, shipment terms, governing rules and any confirmation or reimbursement arrangements.

Use the worked example

Meaning and transaction use

UCP 600 applies when the credit expressly states that it is subject to those rules and defines the applicant, issuing bank, beneficiary, presentation and complying presentation. [S1]

UCP 600 distinguishes credits from underlying contracts and documents from goods, services or performance. [S2]

Transaction control therefore depends on drafting documentary conditions that are objective, obtainable, consistent with the sale contract and capable of timely presentation.

Worked example

Illustrative facility economics only. Assume a 100,000 purchase, a letter of credit covering 90.0% of the purchase price, a 20.0% cash margin against the credit amount, a 1.5% annual issuance fee and a 90-day tenor using a 360-day basis. Assume a complying presentation for the full credit amount.

Scroll the table horizontally to view all columns.

Measure	Calculation	Result
Credit amount	100,000 x 90.0%	90,000
Applicant cash margin	90,000 x 20.0%	18,000
Illustrative financed exposure	90,000 - 18,000	72,000
Indicative 90-day fee	90,000 x 1.5% x 90 / 360	337.50
Amount outside credit coverage	100,000 - 90,000	10,000
Amount honoured on complying presentation	Full complying presentation	90,000

The illustrative credit covers 90,000 of the purchase price, requires an 18,000 cash margin and leaves 72,000 of financed exposure. The fee and payment outcome depend on the actual facility and documentary presentation.

Proposed transaction review process

Define the commercial terms

Reconcile price, Incoterms, shipment, payment, inspection, insurance and required evidence with the sale contract.

Draft the credit

Set applicant, beneficiary, amount, availability, expiry, presentation, documents, banks, rules and tolerances.

Issue and perform

Verify the operative instrument, ship or perform, prepare documents and present within the required place and time.

Examine and settle

Banks examine the presentation, communicate discrepancies and honour, negotiate or refuse according to the credit and applicable rules.

Evidence checklist

Commercial contract

Purchase terms, specifications, shipment, delivery, payment, insurance and dispute provisions.

Credit instrument

Operative text, amendments, UCP reference, amount, dates, documents, confirmation and reimbursement.

Presentation documents

Invoice, transport document, insurance, certificate of origin, inspection and other stipulated evidence.

Compliance and funding

KYC, sanctions screening, facility, margin, collateral, foreign-exchange and settlement instructions.

Decision framework

Situation	Proposed action
A documentary condition is subjective	Replace it with an objective document and issuer requirement before issuance.
The credit conflicts with the sale contract	Amend the mismatch before shipment or performance creates an unmanageable discrepancy.
A presentation contains discrepancies	Assess correction, waiver and refusal deadlines under the credit and applicable rules.
The issuing-bank risk is unacceptable	Assess confirmation or another risk-mitigation structure with the relevant bank and advisers.

Common errors to check

Assuming the bank inspects or guarantees the underlying goods.
Using documentary requirements that the beneficiary cannot obtain or present on time.
Ignoring expiry, place of presentation, shipment dates or amendment acceptance.
Treating letter-of-credit coverage as eliminating applicant, bank, country, fraud, sanctions or documentary risk.

Align the credit with the trade

Bring the sale contract, proposed credit wording, shipment timetable, documentary requirements, facility terms and compliance evidence to a letter-of-credit review. Identify conflicts and impractical conditions before issuance or shipment.

Discuss the transaction

Primary references and editorial scope

ICC Digital Library, UCP 600 Articles 1 and 2
Application of UCP 600 and core documentary-credit definitions. Reference checked 17 September 2026.
ICC, UCP 600 Uniform Rules for Documentary Credits
Documentary-credit rules, including credits versus contracts and documents versus goods or performance. Reference checked 17 September 2026.

Editorial qualification

General trade-finance education. Figures are hypothetical. Rights, obligations, fees, sanctions treatment and document standards depend on the instrument, incorporated rules, facility, banks, trade terms and governing laws.

General business information. Obtain advice appropriate to the legal, tax, accounting and financing facts. No offer, lender commitment or transaction outcome is represented. All worked examples use expressly assumed figures. Editorial draft date: 17 September 2026.