Glossary · UK
What is Letter of Credit?
A bank's written guarantee to pay a seller on behalf of a buyer, provided agreed documents and conditions are met, commonly used in international trade.
Full Definition
A letter of credit (LC) is a formal commitment issued by a buyer's bank to pay a seller a specified sum, provided the seller presents agreed documents -- such as a bill of lading, commercial invoice, and inspection certificate -- proving that goods have been shipped or a service delivered in line with the terms agreed. It is widely used in international trade because it substitutes the buyer's own creditworthiness with that of a bank, giving the seller confidence that payment will be made once contractual conditions are satisfied, even where the buyer is based overseas, in an unfamiliar jurisdiction, or is not yet a trusted trading partner. A confirmed letter of credit adds a second bank's guarantee (usually in the seller's own country), providing extra protection against the risk that the buyer's bank or country experiences its own financial or political difficulties, which is common for exporters trading with counterparties in higher-risk markets. Because a letter of credit relies entirely on the documents presented matching the agreed terms exactly -- a discrepancy as small as a mismatched date or missing signature can cause a bank to refuse payment -- exporters and importers typically need careful administration or specialist trade finance support to avoid payment delays or disputes over technical non-compliance rather than genuine performance issues.