The investor’s field guide · L
Letter of credit
A bank commitment, arranged by the buyer, to pay a seller once specified documents are presented, used to reduce payment risk between parties who do not already trust each other.
Explained by the editorial team
A letter of credit is issued by the buyer's bank and sent to the seller, usually through the seller's own bank. It commits the issuing bank to pay the seller once the seller presents documents that match agreed conditions: typically a commercial invoice, a packing list, and proof of shipment such as a bill of lading. The buyer sets these conditions when the letter is opened, including shipment dates and any inspection certificate required.
What it protects, and what it does not
A letter of credit shifts payment risk from trusting the seller to trusting a bank. The bank pays against documents, not against the goods themselves, so a seller who ships the wrong items but presents matching paperwork can still be paid. Buyers often require a pre-shipment inspection certificate as one of the documents, so a letter of credit and an independent inspection work together rather than replacing each other.
What to examine
Check who bears the bank fees, which are higher than a standard transfer. Confirm whether the letter is irrevocable, meaning it cannot be changed without both sides agreeing, and whether a bank in your own country has confirmed it, which matters if the issuing bank is somewhere whose banking system you do not otherwise trust. Terms and costs vary by bank and country, so confirm the current position with your own bank before relying on one.
General information, not investment, legal or tax advice. Examples are illustrative. Read the disclaimer.