What is a letter of credit?

Intention
A letter of credit is a written undertaking given by a bank on behalf of the customer to pay the exporter an
amount of money within a specified time frame provided that the exporter complies strictly with its terms
and conditions. Payment will depend on the exporter presenting documents that conform to the terms laid
down in the letter of credit. The customer’s aim is that he should get the goods that he has ordered, and
the exporter’s aim is to receive payment for them.

Security
Generally speaking, a letter of credit is a safer way of obtaining payment than relying on open account
payment terms. The essential point is that the payment undertaking is moved from the customer to a bank.
It is commonly thought that this represents a more secure source of payment. It is important to bear in
mind that a letter of credit:
 Is separate from the contract to which it relates
 Requires that all parties deal only in documents
 Is not a contract between buyer and seller
 Is not a guarantee that the seller will definitely receive payment
 Is not a guarantee that the buyer will receive the goods he ordered

Confirmation
Confirmation of a letter of credit is an additional undertaking from another bank, the confirming bank
(usually the advising bank), to pay the exporter on presentation of correct documents in conformity with
the letter of credit. To have value to the exporter the confirming bank should be a bank based in the
country of the exporter; it thus removes the political risk of waiting for payment from an overseas bank or
one of its branches.

There are a number of advantages to the exporter in having a letter of credit confirmed:
 He has the undertaking of two banks to pay
 The credit risk is reduced to that of the UK bank
 Country risk is eliminated after conforming documents have been presented (NB pre-delivery risk
is still an issue; can the exporter produce the documents required?)

The principal disadvantage to the beneficiary is the extra cost in the form of the confirmation fee (which
is generally paid by the exporter). The confirmation of the letter of credit only adds to the security for the
exporter if the documents (at step 10 below) can be produced.

How does it work?

1) Contract between the exporter and the customer in which the need for a letter of credit is
specified
2) Customer requests bank to issue letter of credit
3) Customer’s bank issues letter of credit via advising bank
4) Advising bank passes on terms of the letter of credit to the exporter
 5) Exporter nearly always requests amendments to the letter of credit and copies request to advising
bank (if no amendments required ignore 5 to 8)
6) Customer requests issuing bank to issue amendment
7) Amendment issued
8) Amendment advised to exporter (repeat 5 to 8 until letter of credit is acceptable to exporter)
9) Goods dispatched
10) Documents required by the letter of credit presented to the advising bank
11) Issuing bank’s account with advising bank debited (or reimbursement is claimed)
12) Payment made by the advising bank to the exporter
13) Documents passed to issuing bank
14) Documents passed to customer (enabling him to use the bill of lading to obtain the goods if sent
by sea) and payment made by customer to customer’s bank

It is the documents at step 10 which drive the transaction. If the letter of credit calls for documents that
the exporter cannot provide or sets out conditions that the exporter cannot meet the exporter will not be
paid from the letter of credit.
Whilst some of the documents required by the letter of credit will be produced by, and hence be within
the control of, the exporter it is important to remember also those third party documents which are most
commonly required, that is, those which are not produced by the exporter. These are generally (but there
could be others):
 Transport documents, commonly bill of lading or air waybill
 Insurance document (policy or certificate)
 Certificate of Origin (which may require certification and/or legalization by an independent body
such as a Chamber of Commerce or foreign embassy)
 Inspection Certificate

Ebrima B. Sawaneh (ACCA)

Mansa4all@yahoo.com
Common discrepancies encountered by banks examining documents under letters of credit
include the following:
1. Documents are inconsistent with each other.
2. Documents were presented more than 21 days after date of shipment (or other presentation
period specified in the L/C).
3. Full set of bills of lading was not presented or other required documents are missing.
4. Draft is drawn incorrectly or for the wrong amount.
5. Draft is not signed or not endorsed.
6. Invoice does not describe merchandise in exact accordance with the letter of credit. Note: If
the letter of credit describes merchandise in a foreign language, then the exporter must
describe the merchandise in that language in the invoice; translations are not acceptable.
7. Invoice does not show the same shipping terms as specified in the L/C.
8. Invoice includes charges inconsistent with the shipping terms in the L/C.
9. Invoice is not made out in the name of the applicant shown in the L/C.
10. Insurance coverage is insufficient or does not include the risks specified by the L/C.
11. Insurance certificate or policy is not endorsed.
12. Insurance certificate is dated later than the shipment date (acceptable if coverage is
warehouse-to-warehouse).
13. Bill of lading is not clean (defective condition of goods or packaging is indicated).
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14. Bill of lading does not clearly indicate the name and capacity of the signer and who the
carrier is (must be signed “ABC Co. as carrier” or “XYZ Co. as agent for ABC Co., the
carrier”).
15. Bill of lading is not consigned correctly or is not endorsed (if endorsement is required).
16. Multimodal bill of lading was presented when L/C calls for port-to-port, or simply “ocean,”
bill of lading (acceptable if “on board” notation includes the name of the vessel and the
port of loading).
17. Multimodal bill of lading was presented when shipping terms are FOB (i.e., port to port)
and does not indicate inland freight has been prepaid or otherwise fails to meet
requirements for port-to-port shipment.
18. Bill of lading is not marked “freight prepaid” or “freight collect” as required under the
credit or in agreement with the invoice and shipping terms.
19. Not all documents show license numbers, letter of credit numbers, or other identification
required in the credit.
20. Documents are not signed in accordance with L/C terms (any document called a
“certificate” must be signed).