Glossary · Invoice finance
Letter of credit
Also called Documentary credit
A letter of credit is a bank’s promise to pay a seller once the seller presents documents that meet the letter’s conditions, used mostly in trade.
With a letter of credit, the buyer’s bank commits to pay the seller, provided the seller presents the documents the letter specifies — invoices, shipping documents, certificates — on time and exactly as described. The seller relies on the bank’s credit rather than the buyer’s.
Most letters of credit follow the International Chamber of Commerce rules known as UCP 600. Banks pay on the documents, not on the goods, so discrepancies in paperwork are the most common reason payment is delayed.
Letters of credit are common in international trade in goods and large projects. They are rarely practical for routine service invoicing, where deposits, progress billing and credit insurance do the same job more simply.
Example
An exporter ships €200,000 of machinery to a new customer abroad under a letter of credit. It presents the bill of lading and invoice to the bank, the documents comply, and the bank pays.