What is a Letter of Credit? Meaning, Types & Use in International Trade

A letter of credit is a promise by a bank. It says the seller will get money when the job is done. This helps people in different countries trade safely. It is mostly used for big or risky trades.

Ravi, a garment exporter from Delhi, received his first international order—10,000 shirts worth ₹50 lakh, from a retailer in Spain. Since the buyer was new, Ravi requested a Letter of Credit from the Spanish bank, confirmed by his Indian bank. 

After shipping the goods and submitting documents like the bill of lading and invoice, ₹50 lakh was credited to his account within 5 days. Even if the buyer had defaulted, the bank would’ve ensured full payment.

This blog will help you understand what a Letter of Credit is, its types, and how it protects both buyers and sellers in global trade.

Why Are Letters of Credit Used in International Trade?

Letters of credit are used widely in international trade to reduce the risk of non-payment. When buyers and sellers do not know each other or do not trust each other fully, a letter of credit provides safety. It is often used when businesses are in different countries, where rules, time zones, and legal systems are not the same.

According to World Bank Data 2024, over $32 trillion worth of global trade was supported through letters of credit in the last financial year. This shows how important and trusted they are.

Both buyers and sellers benefit:

• Buyers can delay payment until goods are shipped
• Sellers are assured of payment if they follow the rules
• Fraud is avoided as the bank checks all documents
• Trust is not needed; the bank takes the role of a middleman

Example: Meena, a spice exporter in Chennai, received an order worth ₹25,00,000 from a new buyer in Germany. As she had never worked with them before, she asked for a letter of credit. The buyer’s bank in Germany issued it, and Meena’s Indian bank confirmed it. 

When she sent all documents after dispatch, the money was paid in 4 working days, even though she had no personal contact with the buyer.

How a Letter of Credit Works?

Every letter of credit follows a clear process. First, the buyer and seller agree on the deal. The buyer then goes to the bank and asks for a letter of credit. The bank checks everything and sends the LC to the seller. After goods are shipped, the seller shows all the agreed documents to the bank. If everything is right, the money is paid.

Steps in Getting a Letter of Credit

Here’s a simple step-by-step breakdown of how a Letter of Credit works in international trade:
 

These steps ensure secure and timely payments between buyers and sellers across borders.

Example: Faizan, a small business owner in Mumbai, imported kitchen tools worth ₹18,00,000 from Korea. A letter of credit was issued by his bank within 3 days after checking his documents and credit score. 

Once the seller shipped the tools and shared all bills, Faizan’s bank released the full amount in 2 working days. The tools arrived in 15 days, and no delay or risk was faced.

Types of Letters of Credit

There are many Types of Letters of Credit to help businesses feel safe when they import or export. Each type is made for a different purpose. Some are safer, some are more flexible, and some are made for big or regular trades.

Letters of credit are used when money is big and trust is low. The right type of letter of credit can protect both the buyer and the seller.
 

Example: Tanya from Surat signed a deal with a boutique in Singapore. She had to send ₹10,00,000 worth of saris every month for a full year. 

A Revolving Letter of Credit was used. It allowed her to get paid every time without applying again. This type helped her work easily and grow her business.

Irrevocable vs Revocable Letters of Credit

Choosing the right one matters a lot. Most people now use irrevocable letters of credit because they are more secure. A revocable letter of credit can be risky since the bank or buyer can cancel it without asking the seller.
 

Example: Deepak, an electronics exporter from Noida, had a deal worth ₹42,00,000 with a retailer in Dubai. He trusted the buyer and agreed to a Revocable LC. But one week before shipping, the buyer cancelled it. Deepak faced losses. 

Later, when another order worth ₹50,00,000 came, he chose an Irrevocable Letter of Credit. That deal was completed safely, and the money was received within 3 working days.

How to Apply for a Letter of Credit?

The application for a letter of credit is not difficult. The buyer fills a form at their bank. The bank checks the buyer’s background, credit, and trade papers. After approval, the letter is sent to the seller’s bank. This makes the seller feel safe, and trade can begin.

Steps to Apply:

• Buyer shares trade details
• The bank checks the buyer’s history
• Documents like invoices, contracts, and shipping plans are submitted
• Approval and LC issued in 3–5 days
• Sent to the seller’s bank for confirmation

Documents Needed:

• Sale Agreement or Invoice
• Buyer and Seller IDs
• PAN Card and GST details (if in India)
• Details of shipment (dates, type of goods, etc.)

Example: Shruti from Jaipur wanted to import Italian furniture for her showroom. The cost was ₹30,00,000. She went to SBI and applied for a Letter of Credit. Her documents were checked, and the LC was approved in 5 days. 

After the goods were shipped from Italy, payment was made quickly. Her business opened on time, and the deal went smoothly.

Costs Involved in Getting a Letter of Credit

The cost of getting a letter of credit is not the same everywhere. Most banks charge between 0.75% and 1.5% of the full deal value. There may also be extra charges for paperwork or service. 

These costs are taken by the buyer, and they must be paid at the time of opening the letter of credit. Bigger deals or riskier trades may be charged a little more.
 

When Should You Use a Letter of Credit?

A letter of credit is useful in many trade cases. It is used mostly when the buyer and seller do not know each other or when the trade is very big. Sometimes banks also ask for a letter of credit before allowing an international deal. When goods are being shipped far or when payment terms are strict, a letter of credit makes sure the seller gets paid only if the work is done as agreed.

You should use a letter of credit when:

• The buyer is new or unknown
• The amount is large (₹10 lakhs or more)
• The country's rules are different
• There is a risk of fraud
• Payment is delayed
• The seller wants safety

Conclusion

Letters of credit have been trusted in international trade for many years. They are used by businesses to make sure payments are made on time. Many types of letters of credit are available to suit different needs. Some are made for big deals, while others help sellers who need money early. 

Buyers and sellers who work with new people or across countries find them very helpful. Banks take care of checking documents and handling payments. Because of this, trades happen smoothly and without fear. Letters of credit continue to be a strong and safe method for global trade in 2025.

FAQs

1. What makes a Confirmed LC safer for exporters?

A Confirmed LC adds a second bank's guarantee (usually in the exporter’s country), ensuring payment even if the foreign buyer or their bank defaults.

2. When is a Standby LC better than a regular LC?

A Standby LC is ideal for long-term service contracts where actual payments may not be needed unless the buyer fails to perform, acting like a safety net.

3. Can fraud still occur with LCs?

Yes. If fake or misleading documents are submitted, banks may still release funds. Strict due diligence and document checks are essential to prevent this.

4. Why are Transferable LCs risky in complex supply chains?

They involve multiple parties, increasing chances of miscommunication, delays, or errors, especially if second beneficiaries aren’t well coordinated.

5. What’s the role of UCP 600 in LC transactions?

UCP 600 is the global rulebook that standardises LC operations. Misreading its clauses, like what counts as a “complying presentation”, can delay or cancel payments.
 

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