A letter of credit, also called a documentary credit, is a bank's promise to pay an exporter once the exporter hands over a specified set of documents. That one sentence carries most of the idea. This article takes it apart term by term, using the rules most credits are issued under, UCP 600, so that the words you will meet on your first credit mean something precise before the documents are due.
An exporter does not want to ship goods to a buyer abroad and then wait, unsecured, to be paid. The buyer does not want to pay in advance for goods that have not left the factory. A documentary credit puts a bank between the two: the buyer's bank promises to pay the exporter, provided the exporter proves shipment and the other agreed facts with documents. The exporter relies on the bank's promise instead of the buyer's, and the buyer knows that no money moves until the documents say what the credit requires.
Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.
Three words in that definition matter from day one. "Irrevocable" means the bank cannot withdraw or change the promise on its own once the credit is issued. "Honour" means to pay, either at once or on a later date the credit fixes. "Complying presentation" is the condition the whole arrangement hangs on, and it is explained further down.
Who is involved
Applicant means the party on whose request the credit is issued. Beneficiary means the party in whose favour a credit is issued.
- Applicant: the buyer, or importer. It asks its bank to issue the credit and is the party the bank will later look to for reimbursement.
- Beneficiary: the seller, or exporter. It is the party entitled to be paid if it presents the right documents in time.
- Issuing bank: the bank that issues the credit at the applicant's request. Its promise to pay is the core of the credit.
- Advising bank: usually a bank in the exporter's country that passes the credit on to the beneficiary. Advising alone creates no obligation to pay.
- Confirming bank: a bank that adds its own promise to pay on top of the issuing bank's, at the issuing bank's request or with its authorisation. Exporters ask for a confirmation when they want a second, often local, bank on the hook.
- Nominated bank: the bank with which the credit is available, where the beneficiary may present documents. It is often the same bank as the advising or confirming bank.
Documents, not goods
Banks deal with documents and not with goods, services or performance to which the documents may relate.
This is the single most important idea in the whole system, and it surprises almost everyone the first time. The bank does not inspect the goods, visit the port or read the sales contract. It checks whether the documents it receives match the credit. Perfect goods with a wrong document can be refused. The reverse also holds: documents that comply must be paid even if the buyer later finds fault with the goods, because that dispute belongs to the sales contract, which the credit is separate from under Art. 4(a).
Presentation, compliance and discrepancy
Complying presentation means a presentation that is in accordance with the terms and conditions of the credit, the applicable provisions of these rules and international standard banking practice.
A presentation is the act of delivering the documents to the issuing bank or to a nominated bank, and also the set of documents so delivered: typically a commercial invoice, a transport document such as a bill of lading, and whatever else the credit lists, for example a packing list or a certificate of origin. The definition above measures that set against three sources: the credit itself, UCP 600, and international standard banking practice, which the ICC has written down in a separate publication, ISBP 821. The bank has at most five banking days after the day of presentation to decide (Art. 14(b)). A discrepancy is any point on which the documents do not comply: a shipment date after the latest date the credit allows, an invoice whose goods description does not correspond to the credit, a missing document, a bill of lading without the required on board notation. One discrepancy is enough for the bank to refuse.
When a nominated bank acting on its nomination, a confirming bank, if any, or the issuing bank determines that a presentation does not comply, it may refuse to honour or negotiate.
A refusal is not the end of the transaction. The bank must send a single notice that lists every discrepancy it relies on (Art. 16(c)). If the credit has not expired and the period for presentation has not run out, the exporter can correct the documents and present again. Otherwise the issuing bank may ask the applicant whether it will waive the discrepancies (Art. 16(b)). Refusal on first presentation is common: ICC Academy estimates that 65-75% of documentary-credit presentations are refused on first presentation (ICC Academy, "11 Questions that will help you master documentary credits", updated 8 August 2024). Many of those refusals are resolved in the end, but each one still costs rework, fees and delay.
A letter of credit is a bank's promise to pay against documents. The bank reads only the documents, measures them against the credit, UCP 600 and standard banking practice, and may refuse on any discrepancy. Getting the documents right is the exporter's whole job.
This article explains general practice under UCP 600. It is not legal advice, and the terms of your own credit always come first.
This article sets out the rules as we understand them and is not legal advice. What governs is the wording of the specific credit, the applicable ICC rules as in force, and the determination of the examining bank or customs authority in the individual case.