LC
A bank-issued guarantee that the seller will receive payment on time and for the correct amount, provided the seller presents shipping and compliance documents that meet the conditions stated in the LC.
A Letter of Credit (LC) is a written undertaking issued by a bank, at the request of a buyer (the applicant), promising to pay a seller (the beneficiary) a defined sum once the seller presents documents that match the terms and conditions of the LC. In effect, the buyer's credit risk is replaced by the issuing bank's credit risk, which is usually far easier for a seller to underwrite and price.
LCs are most common in cross-border B2B trade where the parties do not know each other, where political or currency risk is elevated, or where the order value is large enough that bank-grade payment assurance is worth the cost. They also appear in domestic trade for first-time customers, distressed buyers, or industries (construction, commodities, capital equipment) where open credit terms carry unacceptable exposure. For an AR or credit team, an LC is a tool for saying yes to a deal that would otherwise breach the credit policy.
There are two main families of LC, and they serve different commercial purposes.
Both can be revocable or irrevocable, although in modern practice almost all LCs are irrevocable, meaning the issuing bank cannot cancel or amend without consent of all parties.
A typical commercial LC involves four parties (buyer, buyer's bank, seller's bank, seller) and follows a predictable sequence.
If documents contain discrepancies (wrong date, mis-spelled name, missing signature), the bank can refuse to pay until they are corrected or the buyer waives the discrepancy. Discrepancies are the single largest cause of LC delay and the reason AR teams treat document accuracy as a priority.
LCs are governed internationally by the Uniform Customs and Practice for Documentary Credits, currently in its 2007 revision known as UCP 600, published by the International Chamber of Commerce. Almost every cross-border LC is issued subject to UCP 600, which standardises definitions, bank obligations, document examination rules, and discrepancy handling.
Two related rulebooks matter for AR teams. ISP98 governs Standby LCs in many US-issued instruments, and eUCP supplements UCP 600 for electronic document presentation. The practical effect is that LC terms are interpreted the same way whether the issuing bank sits in Frankfurt, Singapore, or Sao Paulo, which makes the instrument predictable and bankable.
LCs are not free. Total issuance, advising, confirmation, and amendment fees typically run between 0.5% and 2% of LC value, paid by the buyer. On a 2 million euro shipment, that is 10,000 to 40,000 euros in bank fees, plus 3 to 10 business days of processing time per leg.
Compared with the alternatives, the picture looks like this:
For routine business with rated counterparties, open account plus credit insurance usually wins on cost and speed. For new markets, weak-credit buyers, or any deal large enough that a single loss would be material, the LC remains the standard.
LC operations have historically been one of the most paper-heavy corners of B2B finance. AI-native trade finance platforms now read shipping documents, compare them field-by-field against LC terms, and surface discrepancies in seconds rather than the two to three days a human examiner needs. For AR teams on the seller side, the practical impact is faster document preparation, fewer rejected presentations, and shorter days-sales-outstanding on LC-backed invoices.
Agentic workflows are extending further into application, amendment, and reconciliation steps, with models drafting LC requests from sales order data, flagging incoterm mismatches before submission, and posting cash receipts against the right invoice once the bank settles. The instrument itself remains a 400-year-old legal construct, but the documentation layer around it is now moving at software speed.
The buyer (applicant) pays the issuing fee to their bank, typically 0.5% to 2% of LC value. The seller may pay smaller advising or confirmation fees to their own bank, especially if they ask for the LC to be confirmed by a bank in their jurisdiction. The split is negotiable and should be spelled out in the underlying sales contract.
A commercial LC is the primary payment mechanism: the bank pays the seller on document presentation. A bank guarantee, like a Standby LC, is a backup instrument that only pays if the buyer fails their primary obligation. In day-to-day European trade finance, Standby LCs and bank guarantees are often used interchangeably, although they sit under different legal frameworks (UCP 600 or ISP98 for SBLCs, national law for guarantees).
Issuance usually takes 3 to 10 business days once the buyer submits a complete application and collateral or credit facility is in place. Amendments add 1 to 3 days each. Document examination after the seller ships typically takes another 5 banking days under UCP 600. AI-native document tools are compressing the examination step significantly.
The bank flags the discrepancy and can refuse to pay. The seller then either corrects and re-presents the documents (if there is time within the presentation window), asks the buyer to waive the discrepancy, or accepts a reduced payment. Roughly 60% to 70% of LC presentations contain at least one discrepancy on first submission, which is why document accuracy is treated as a priority by experienced exporters.
Common triggers are: a new customer in a high-risk country, an order value large enough that a single bad debt would be material, a buyer whose credit score or financials fall below the credit policy threshold, or a market where credit insurance coverage is unavailable or capped. For routine business with rated counterparties, open account with credit insurance is usually cheaper and faster.
An irrevocable LC, which is the modern standard, cannot be cancelled or amended without the consent of all parties (buyer, seller, issuing bank, and any confirming bank). Revocable LCs technically allow unilateral cancellation by the issuing bank, but they offer little protection and are rare in current practice. UCP 600 treats all LCs as irrevocable unless explicitly stated otherwise.
