Quick answer
A letter of credit is a bank's written undertaking to pay a seller a set amount, provided the seller presents documents, such as an invoice and bill of lading, that match the credit's terms exactly. It lets an Australian importer reassure an overseas supplier, and lets an exporter rely on a bank rather than a foreign buyer. Most are issued under the ICC's UCP 600 rules.
Key points
- The bank pays against documents, not against the goods themselves
- Most letters of credit follow the ICC's UCP 600 rules, in force since 1 July 2007
- A single mismatch in the paperwork can delay or block payment
- Issuing one uses up part of your trade facility limit, much like a bank guarantee
International trade has an old trust problem. The overseas supplier doesn’t want to ship until it’s paid, and the Australian buyer doesn’t want to pay until the goods are on the water. A letter of credit, sometimes called a documentary credit, solves it by putting a bank in the middle.
Who’s involved in a letter of credit?
| Party | Role |
|---|---|
| Applicant | The buyer (often an Australian importer) who asks its bank to issue the credit |
| Issuing bank | The buyer’s bank, which promises to pay |
| Beneficiary | The seller, who gets paid when it presents compliant documents |
| Advising bank | A bank in the seller’s country that passes the credit on and checks it’s genuine |
| Confirming bank | Optional: a bank that adds its own promise to pay on top of the issuing bank’s |
How does payment actually happen?
- Buyer and seller agree in their contract to use a letter of credit.
- The buyer’s bank issues the credit, listing exactly which documents it needs: typically a commercial invoice, bill of lading, packing list, certificate of origin and sometimes an inspection certificate.
- The seller ships and presents those documents.
- The bank examines them. Under UCP 600 it has a maximum of five banking days to decide whether they comply.
- If they match, the bank pays, either at sight (straight away) or at an agreed later date, known as a usance or term credit.
The important point is that banks deal in paper, not goods. If the bill of lading shows the right port and dates, the bank pays, even if the cartons turn out to be damaged. Quality disputes are sorted out between buyer and seller under their contract.
Why do discrepancies matter so much?
Compliance is strict. A misspelt company name, a late shipment date or a missing signature can be a discrepancy, and the bank is entitled to refuse. For exporters that’s the main risk: the protection only works if the paperwork is perfect. For importers it’s the main safeguard. Agreeing simple, achievable document requirements upfront saves a lot of grief.
What does it cost, and how does it affect borrowing?
Banks charge fees to issue, amend and pay a credit, and confirming banks charge on top. The bigger cost is often hidden: the credit uses up part of your trade facility limit until it’s paid, just as a bank guarantee does, and that limit usually needs security. A lender assessing other finance will count open credits as a contingent liability.
Funding a shipment and the bank’s trade limit is full? Ask us about trade finance.
Example: a Brisbane importer
A furniture retailer in Brisbane orders $180k of stock from a Vietnamese manufacturer that insists on a letter of credit. The retailer’s bank issues a 60-day usance credit. The supplier ships, presents its documents, and is paid by the bank on day 60. The retailer gets the stock on the floor and two months of sales before the money leaves its account. If its bank limit had been too small, import finance or broader trade finance from a specialist could have paid the supplier directly instead. Businesses selling overseas rather than buying can also approach Export Finance Australia, a Commonwealth agency offering loans and guarantees to exporters.
Need to fund stock from overseas?
Whether you’re paying a supplier abroad or waiting for a foreign customer to pay you, working capital is usually the pinch point. Telling us about it takes a minute or so, and sending it leaves your credit score untouched. One person on our side reviews what you’ve told us, then calls; nothing gets fired off to a list of funders. Give us accurate shipment sizes and timings so we can match the right facility straight away.
Frequently asked questions
What's the difference between a letter of credit and a bank guarantee?
A commercial letter of credit is meant to be drawn: it's the normal way the seller gets paid. A bank guarantee is a fallback that's only called if you fail to perform. A standby letter of credit sits in between and works much like a guarantee.
How long does it take to get a letter of credit?
If you already have a trade finance facility with your bank, issuing a credit can take a few business days once the terms are agreed with the supplier. Without a facility, the bank first has to approve one, which takes longer.
What is a confirmed letter of credit?
It's one where a second bank, usually in the seller's country, adds its own promise to pay. Exporters ask for confirmation when they're unsure about the issuing bank or the buyer's country.
What happens if the documents don't match?
The bank can refuse to pay. Often the importer is asked to waive the discrepancy, but that hands control back to the buyer and removes much of the seller's protection, which is why careful document preparation matters.
Can a small business use letters of credit?
Yes, but the bank will want a trade facility in place, usually supported by security such as property or cash. For smaller or occasional shipments, many businesses use trade finance from a non-bank lender instead.