In international trade, guaranteeing secure payments is key to avoiding risks and disputes. The letter of credit is one of the most widely used solutions to ensure that buyers and sellers meet their commitments without problems.
This document, issued by a financial institution, protects both parties, ensuring that payment is only made if the agreed conditions are met. Its use is essential in cross-border transactions, where trust and security in payments are essential.
In this article, you will find out what a letter of credit is, how it works, what types exist and how to choose the right one according to the type of transport and the risk level of your operation.
What is a letter of credit?
A letter of credit or documentary credit is a commitment to pay issued by a bank on behalf of the buyer, guaranteeing that the seller will receive the money if certain conditions are met.
The bank acts as an intermediary and only releases funds when the seller presents the required documents, such as invoices and shipping certificates.
Why is it important?
✔ Minimizes risks: Ensures that the buyer will only pay if the terms are met.
✔ Greater confidence: Protects both parties in international transactions.
✔ Guarantees payment and delivery: The bank verifies that everything is in order before releasing the money.
It is a key tool in foreign trade, especially in high-value operations or with new trading partners.
Operation of the letter of credit
The operation of a letter of credit follows several key steps to ensure the security of payment and delivery of the goods.
Step 1: Issuance of the letter of credit
The buyer requests his bank to issue a letter of credit in favor of the seller, specifying the documents that the seller must present to receive payment (invoices, packing list, certificate of origin, etc.).
Step 2: Submission of documents
The seller sends the goods and submits the required documentation to the intermediary bank (designated bank in your country).
Step 3: Verification and payment
The seller’s bank reviews the documents and, if they comply with the established terms, authorizes the buyer’s bank to release the payment.
Why is this system safe?
✔ Protection for both parties: The buyer only pays if the conditions are met; the seller secures his collection.
✔ The bank as intermediary: Reduces the risk of fraud or non-payment.
✔ S trict compliance: Documents must match exactly as agreed to release payment.
This method is fundamental in international trade, ensuring that money and goods only change hands when all agreed conditions are met.
Types of letters of credit and which one to choose in each case
Letters of credit adapt to different business scenarios and risk levels. Here are the most common types and when to use them to ensure smooth international payments.
1. Irrevocable letter of credit
It cannot be modified or cancelled without the agreement of all parties. It is the most widely used for its security and is ideal for high value transactions or with new suppliers, as it guarantees payment if the agreed terms are met.
2. Confirmed letter of credit
It includes an extra guarantee from a second bank (confirming bank), which reduces risks when the importer’s country is financially unstable. It is perfect for exports to emerging markets or regions with high economic volatility.
3. Transferable letter of credit
Allows the beneficiary (usually an intermediary) to transfer part or all of the credit to another supplier. It is useful in triangular operations, such as those managed by traders or global distribution companies.
4. Standby letter of credit
It functions as a guarantee of payment in the event of default, rather than as a means of direct payment. It is frequently used in long-term contracts, international projects and services where a performance bond is required.
5. Revolving letter of credit
Designed for recurring transactions, it is automatically renewed under certain conditions without the need to issue a new one. It is ideal for businesses with frequent logistics operations or continuous supply of goods.
Which letter of credit to choose according to the type of shipment
Not all international trade operations have the same needs. The best letter of credit will depend on key factors such as the value of the goods, the frequency of shipment, the level of trust with the buyer and the type of transportation.
Here we explain which option to choose according to each scenario:
For high value shipments
If the goods have a high cost (e.g. machinery, technological products or precious metals), it is advisable to use an irrevocable and confirmed letter of credit.
✅ Why: Secures payment with the backing of two banks, reducing the risk of non-payment.
For recurring shipments
When there is a stable business relationship with frequent deliveries (e.g. raw materials, perishable goods), a revolving letter of credit is the best option.
✅ Why: Allows the credit to be reused automatically without the need to issue a new one for each transaction.
For new customers or risk markets
If you are exporting to a country with financial instability or working with a customer with no trade history, a standby letter of credit is the best guarantee.
✅ Why: It acts as a payment insurance in case the buyer defaults on his obligations.
For projects with multiple suppliers
If a shipment involves several suppliers (e.g. multimodal transport or industrial projects), a transferable letter of credit allows the credit to be distributed among them.
✅ Why: Streamlines payment to different parties without issuing multiple letters of credit.
Depending on the type of transport
If transportation is the key factor, these are the best options:
🚢 Ocean: Irrevocable or confirmed letter to protect high value shipments.
✈️ Air: Standby letter to guarantee delivery times in urgent shipments.
🚛 Ground/rail: Revolving letter for frequent shipments and cost optimization.
📌Choosing the right letter of credit reduces risks and optimizes international transactions. At Across Logistics, we advise you to find the best option according to your type of shipment and commercial operation.
Benefits of the letter of credit in international trade
The letter of credit offers multiple advantages that make it an indispensable element in global trade transactions. It provides security, flexibility and a framework of trust that benefits both buyers and sellers.
Some of the key benefits include:
✅ Risk mitigation: The letter of credit significantly reduces the risk of not receiving payment or merchandise, as the bank guarantees financial and material performance.
✅ Financial security: Provides security to sellers about payment. It is only made if all specified conditions are met, ensuring that there will be no disputes over the delivery of funds.
✅ Enhances the business relationship: Fosters stronger, long-term business relationships by providing a framework of trust and compliance for both parties.
✅ Access to new markets: Facilitates companies’ expansion into new international markets by providing a globally accepted and reliable payment method.
✅ Transaction flexibility: The letter of credit can be adapted to different types and conditions of contracts, allowing its use in a variety of commercial situations and industry sectors.
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Roles and responsibilities in a letter of credit
The effective implementation of a letter of credit involves multiple parties, each with specific responsibilities to ensure the success of the transaction:
Issuing bank: The buyer’s bank that issues the letter of credit, guaranteeing payment to the seller under the agreed conditions.
Receiving (Confirming) Bank: The seller’s bank that receives the letter of credit. It can confirm and therefore also guarantee payment under the terms of the document.
Buyer (Importer): Requests the issuance of the letter and makes sure to comply with the terms for payment.
Seller (Exporter): Provides the goods or services and submits the required documents to the bank to receive payment.
Each party plays a crucial role in ensuring that the transaction is handled efficiently and safely, minimizing risks for all involved.
Required Documentation
For a letter of credit to work effectively, certain documents are required to verify the transaction and ensure the compliance of all parties involved:
📝 Commercial Invoice: Details the transaction, including description of goods, prices and terms of sale.
📝 Packing List: Provides information on the packaging of the goods, helping to identify and verify the products shipped.
📝 Bill of Lading: Document issued by the carrier that proves the shipment of goods.
📝 Certificate of Origin: Declares the country of origin of the merchandise, essential to determine tariffs or comply with trade regulations.
📝 Insurance Policy: Insures the coverage of the goods during transportation.
These documents are crucial to ensure transparency and security in international trade operations, minimizing risks for both seller and buyer.
Common mistakes and how to avoid them
Using letters of credit is not without its challenges. Some common mistakes include:
⚠️ Incorrect documentation: Errors in submitted documents are a common cause of delays and non-payment. Make sure all documents are complete and accurate.
⚠️ Misunderstanding of terms: Sometimes the parties involved do not fully understand the terms of the letter of credit, which can lead to inadvertent defaults.
⚠️ Tight deadlines: Setting unrealistic deadlines for submitting documents or making shipments can result in non-compliance and stress.
Avoiding these mistakes requires meticulous attention to detail, a clear understanding of the terms of the letter, and effective communication between all parties.
Across Logistics: Your partner in international trade
Across Logistics is a key partner for companies seeking to navigate the challenges of international trade. With our expertise in customs management and global logistics, we help our clients effectively use tools such as the letter of credit to secure international transactions.
We offer expert advice and customized solutions to ensure that each operation not only complies with international regulations, but is also run efficiently and cost-effectively.
