How a Letter of Credit Works in Export (Step by Step)

A Letter of Credit (LC) is the most secure common payment method in export because a bank — not the buyer — guarantees payment, provided the exporter presents exactly the documents the LC demands. Understanding how many parties are actually involved removes a lot of the mystery around why LC transactions feel slow or bureaucratic.

The four core parties

1. Buyer (importer) — applies for the LC with their own bank.
2. Issuing bank — the buyer's bank. Issues the LC and is the party ultimately obligated to pay, provided compliant documents are presented.
3. Advising bank — a local bank in the *exporter's* country, used by the issuing bank to deliver and authenticate the LC to the exporter. This step exists because an exporter has no way to independently verify a foreign bank's LC is genuine and not fraudulent — the advising bank does that verification and translates the (often dense, technical) LC wording into plain terms the exporter can act on.
4. Negotiating bank — often the same as the advising bank, but not always. This is the bank the exporter submits their shipping documents to after the goods ship; it checks the documents against the LC's exact conditions and forwards them to the issuing bank for payment.

A fifth, optional party is a confirming bank — a bank in the exporter's own country that adds its own guarantee on top of the issuing bank's, for situations where the exporter isn't confident in the issuing bank's creditworthiness or country risk. This costs extra but removes issuing-bank risk entirely.

The sequence, start to finish

1. Buyer and seller agree terms; buyer applies to their bank (issuing bank) for an LC.
2. Issuing bank issues the LC and routes it through the advising bank in the exporter's country.
3. Advising bank authenticates the LC and passes it to the exporter for review — at this point, the exporter has made no financial commitment yet and should carefully check every documentary condition against what was actually agreed in the sales contract. This is the single best moment to catch a problem, before any goods are produced or shipped.
4. If the exporter accepts, they proceed with production/procurement, arrange shipping, and gather every document the LC demands — commonly the commercial invoice, packing list, certificate of origin, quality certificate, insurance certificate, and the transport document (Bill of Lading or Airway Bill).
5. Exporter presents this full document set, plus a Bill of Exchange (a formal, bank-format payment demand — functionally similar to a cheque), to the negotiating bank.
6. Negotiating bank checks the documents strictly against the LC's stated conditions. If everything matches with zero discrepancies, it forwards the set to the issuing bank and credits the exporter once the issuing bank confirms and pays.
7. Issuing bank releases the original documents to the buyer (who needs them to physically collect the goods from the carrier and clear customs) once the buyer has settled any outstanding amount owed.

Why "compliant documents" is the whole game

Banks under a documentary credit only look at paperwork, never at the actual goods. If the documents match the LC's conditions exactly, payment is made — even if something is later found wrong with the physical shipment. If the documents don't match — a wrong date, a misspelled name, a missing certificate — payment can be refused even if the goods themselves are perfect. This is why consistency across every document in a shipment (sales contract, Proforma Invoice, LC, commercial invoice, transport document) matters more than almost anything else in the whole export process — one mismatched detail can hold up an entire payment.

Sight vs. Usance

• Payable at sight: payment is released as soon as the bank confirms the documents are compliant. This is the safer, faster option for the exporter.
• Usance LC: there's an agreed delay between document acceptance and actual payment (e.g., 30/60/90 days) — effectively the exporter is extending credit to the buyer through the bank. If accepting usance terms, price in a premium to cover that delay; a usance period is a real cost, not a formality.

A practical rule for new exporters

When dealing with a buyer for the first time, default to an irrevocable, confirmed (if possible), sight LC from a reputable international bank until real trust is built over several transactions. It costs more than open account or simple bank collection, but it's the one payment method where the exporter's risk is genuinely covered by a bank's guarantee rather than the buyer's promise.