How to Get a Letter of Credit for Your Business

A Letter of Credit (LC) is a financial instrument issued by a bank that guarantees a buyer’s payment to a seller. This guarantee is useful in international trade. The LC mitigates payment risk for the seller (exporter) and ensures the buyer (importer) pays only when goods or services are provided as agreed. Businesses use LCs for secure cross-border trade and to build trust, as the bank covers unpaid amounts if the buyer defaults, provided the seller fulfills conditions.

Preparing for a Letter of Credit Application

Before applying for a Letter of Credit, businesses must gather information and documentation. This phase establishes LC terms and aids the bank’s assessment. The bank needs applicant (buyer) and beneficiary (seller) details to draft the LC.

The applicant must provide legal name, address, and contact details, along with the beneficiary’s legal name, address, and banking information. Required details also include a description of goods or services (quantity, quality, unit price), total transaction value, currency, and payment terms (sight or usance). Shipping terms, often defined by Incoterms like FOB or CIF, outline responsibilities and costs during transit.

The LC application requires documents the beneficiary must present for payment. These documents are important because the bank’s payment obligation depends on strict compliance. Common documents include a commercial invoice, packing list, bill of lading, certificate of origin, or inspection certificate. The LC’s expiry date and place, and any confirmation requirements, complete the transactional details.

Beyond transaction details, the applicant must provide supporting documents for credit assessment. This includes recent financial statements (balance sheets and income statements) to demonstrate financial standing and repayment ability, and business registration documents to verify legal existence. A copy of the sales contract or proforma invoice provides the bank with the agreement. Depending on creditworthiness and transaction size, the bank may require collateral. The bank assesses financial health, credit history, and the trade transaction to determine its willingness and terms for issuing the LC.

The Letter of Credit Application Process

Once information and supporting documents are prepared, the Letter of Credit application process begins. The applicant submits details to their bank via an online portal, physical form, or bank representative. This submission marks the start of the bank’s review.

Upon receipt, the issuing bank reviews the application, conducting a credit assessment to verify financial capacity and ensure LC terms align with the transaction. The bank scrutinizes conditions for clarity and manageability. If approved, the bank drafts the Letter of Credit, formalizing the commitment to pay the beneficiary.

After drafting and approval, the LC is issued by the bank. The issuing bank transmits the LC, usually via SWIFT, to an advising bank in the beneficiary’s country. SWIFT is a secure messaging system for banks to communicate financial instructions efficiently. The advising bank receives the LC and verifies its authenticity.

The advising bank informs the beneficiary about the LC, providing all terms and conditions. This notification allows the beneficiary to review the LC and confirm its terms match the sales agreement. The beneficiary can fulfill obligations, such as shipping goods, knowing a bank guarantee for payment is in place if they meet the LC’s requirements.

Understanding Letter of Credit Costs and Fees

Obtaining a Letter of Credit involves various costs and fees for businesses. These charges compensate banks for services, guarantees, and risks throughout the LC lifecycle. The primary fee is the issuance fee, charged by the issuing bank for creating and guaranteeing the LC, calculated as a percentage of its value (0.1% to 2% or more), with minimum flat fees from $100 to $500 depending on complexity.

If the LC requires confirmation, an additional confirmation fee is incurred. This fee is charged by the confirming bank for taking on payment risk, ranging from 0.1% to 1% or more of the LC value, sometimes adding 2% to 8% to total bank fees in high-risk scenarios. Confirmation fees may also be calculated based on periods, such as per 30 days until LC expiry, with rates varying based on the issuing bank’s credit and country risk.

Changes to the LC after issuance incur amendment fees. These fees vary depending on the bank and complexity of changes, with charges ranging from $50 to $250 per amendment. Amendments adjust terms like expiry date, quantity, or value, requiring consent from all parties.

Discrepancy fees are charged if documents presented by the beneficiary do not strictly comply with the LC’s terms. Banks charge these fees because discrepancies require additional review and resolution. These fees range from $50 to $225 or more per discrepancy and are deducted from the beneficiary’s payment.

Other charges include advising fees (for notifying the beneficiary of the LC) and negotiation fees (for examining and negotiating documents). SWIFT charges for secure message transmission may also apply. While the applicant bears issuance fees, other fees like confirmation, amendment, and discrepancy charges may be split between the applicant and beneficiary or borne entirely by one party, depending on the sales contract.

Managing the Letter of Credit After Issuance

Once a Letter of Credit is issued, its management shifts to ensuring terms are met for successful payment. The beneficiary prepares and presents required documents to their bank once goods are shipped or service performed. These documents must precisely match every detail specified in the LC, as banks operate under strict compliance.

The nominated and issuing banks examine presented documents against the LC’s terms, confirming all conditions like descriptions of goods, quantities, shipping dates, and document formats are satisfied. Any deviation, even minor, constitutes a discrepancy and can lead to payment delays or refusal. If documents are compliant, the issuing bank honors the LC.

For sight LCs, payment is made promptly after compliant documents are presented and verified. For usance LCs, allowing deferred payment, the bank accepts documents, committing to pay at a future date. The issuing bank releases documents to the applicant, enabling them to claim goods from customs.

Should transaction terms change after LC issuance, an amendment process is required. Either the applicant or beneficiary can request an amendment, such as extending the expiry date, adjusting quantity, or modifying goods description. All parties, including the issuing bank, must agree to proposed changes for the amendment to be valid.

A Letter of Credit has a defined expiry date and concludes upon expiration or payment. If the transaction is completed and obligations satisfied before expiry, the LC fulfills its purpose. In rare cases, an LC might be cancelled before expiry, requiring consent of all parties, including the beneficiary and issuing bank.