To get a letter of credit, you apply through your bank’s trade finance department, which evaluates your creditworthiness, reviews the underlying sale, and — if it approves — issues the credit to the seller’s bank in exchange for a fee and, usually, some form of collateral. Issuance fees typically run 0.75% to 2% of the credit’s face value, and straightforward applications are decided within a few business days. The rest of the process comes down to picking the right type of credit, meeting the bank’s financial requirements, and preparing an application that mirrors your sales contract exactly.
Choose the Type That Fits Your Transaction
Before you apply, decide which kind of letter of credit you need. The choice shapes the paperwork, the fees, and what the bank is actually promising.
A documentary (commercial) letter of credit is the primary payment channel in a sale. The bank pays the seller once the seller presents shipping documents proving the goods were sent as agreed. A standby letter of credit is a backup. The bank only pays if you fail to meet your obligations, so it functions as a guarantee rather than the main way money moves.
Under UCP 600, which governs most international documentary credits, every letter of credit is irrevocable by default. Article 2 defines a credit as “any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.”1AustLII. Revocable Credits and the UCP600 Once the bank issues the credit, it cannot cancel or change the terms without agreement from all parties.
A confirmed letter of credit adds a second bank’s guarantee on top of the issuing bank’s commitment. A confirming bank, usually in the seller’s country, agrees to pay the beneficiary even if the issuing bank cannot. Sellers often ask for confirmation when the issuing bank sits in a country with political or economic instability.2MIGA. Letter of Credit Confirmation Confirmation fees vary with the perceived risk of the issuing bank and its home country.
Two other variations matter in specific situations. A transferable letter of credit lets the original beneficiary redirect part or all of the credit to a third party, which is useful when middlemen source from manufacturers. A revolving letter of credit automatically renews after each draw to cover recurring shipments between the same parties.
Meet the Bank’s Financial Requirements
Banks do not issue letters of credit to anyone who asks. The bank is putting its own funds and reputation on the line, so it needs confidence that you can reimburse it after it pays the seller.
An existing banking relationship is the starting point. If you already hold commercial accounts, maintain credit facilities, or have done previous trade finance with the bank, you are in a stronger position than a first-time applicant walking in cold. Lenders look at your business credit history, cash flow, and overall financial health, and most institutions expect at least two years of audited financial statements or tax returns to see a track record of managing debt responsibly. Newer businesses without that history face a harder path and will almost certainly need to post more collateral.
Post the Collateral
Collateral is where many applicants get tripped up. Banks frequently require a cash deposit equal to 100% of the letter of credit’s face value, especially for applicants without strong credit profiles. Federal regulations for standby letters of credit allow banks to require payment or a segregated deposit equal to the bank’s maximum liability before or at issuance.3eCFR. 12 CFR 337.2 – Standby Letters of Credit That deposit stays tied up for the life of the credit, so factor the opportunity cost into your planning.
If you cannot lock up that much cash, banks may accept marketable securities, existing credit lines, or real property as alternative collateral. Expect a haircut on non-cash assets. Securities-backed arrangements, for example, may only let you borrow 50% to 95% of the portfolio value depending on the asset types, meaning you would need to pledge substantially more in securities than the credit’s face amount to cover the gap.
Prepare the Application
The formal application comes from your bank’s trade finance department. You will need to supply precise details for both yourself (the applicant) and the seller (the beneficiary): full legal names, registered addresses, and contact information. Any mismatch between the application and the underlying sales contract creates problems downstream.
The core of the application describes the transaction itself. You will specify the exact dollar amount, the expiration date, and a detailed description of the goods, including quantities, unit prices, and quality specifications. Shipping terms need to be spelled out: port of loading, destination, and any required shipping method. All of this should mirror the pro forma invoice or sales contract word for word.
List the Documents the Seller Must Present
UCP 600, published by the International Chamber of Commerce, is the international framework that governs most documentary credit transactions.4ICC Academy. Uniform Rules for Documentary Credits (UCP 600) A central part of your application is listing which documents the beneficiary must present before the bank releases payment. The bank pays against documents, not goods. If the documents comply, the bank pays. If they do not, the bank refuses.
Common documents to require:
- Bill of lading, which proves the goods were shipped and identifies the carrier, route, and consignee.
- Commercial invoice, detailing the goods sold with quantities, unit prices, and total value.
- Insurance certificate, confirming the cargo is insured against loss or damage in transit.
- Packing list, describing how the goods are packed and the contents of each unit.
- Certificate of origin, identifying where the goods were manufactured, often required for customs clearance.
Name each document specifically. Vague language creates ambiguity when bank examiners review the presentation later. Writing “shipping document” instead of “clean on-board ocean bill of lading” leaves the bank and the beneficiary guessing what satisfies the requirement.4ICC Academy. Uniform Rules for Documentary Credits (UCP 600) Roughly 65% to 80% of documentary credit presentations are rejected by banks on first submission because of discrepancies between the documents and the credit terms, so precision in the application saves everyone time later.5ICC Academy. 25 Tips to Avoid Common Documentary Credit Issues
Budget for the Fees
Letters of credit are not cheap. Issuance fees generally run 0.75% to 2% of the credit’s face value per year, depending on the bank, the complexity of the transaction, and the perceived risk. Smaller or shorter-term credits typically carry a minimum fee of a few hundred dollars regardless of the percentage calculation. These costs fall on the applicant, not the beneficiary.
Beyond issuance, expect:
- Amendment fees, charged each time you change the credit’s terms after issuance, such as extending the expiry date or adjusting the amount.
- Discrepancy fees, charged when the beneficiary’s documents do not match the credit terms and the bank must process the discrepancies. These commonly range from $50 to $225 per presentation.
- Advising fees, charged by the advising bank in the beneficiary’s country for authenticating and delivering the credit.
- Confirmation fees, if the credit is confirmed, running 1% to 2% or more annually for higher-risk issuing banks or countries.
On a large international shipment, total banking charges across issuance, confirmation, and document handling can add up to a significant expense. Add them to the purchase price when you calculate procurement costs.
The Bank’s Review and Your Reimbursement Agreement
Once you submit the completed application, the bank’s trade finance team runs it through an internal review. A credit committee evaluates whether you have sufficient assets or credit limits to support the obligation. The bank treats this much like a loan approval: can you reimburse the bank after it pays the beneficiary?
For straightforward domestic transactions, a decision typically comes within a few business days. International deals involving multiple jurisdictions, unfamiliar beneficiaries, or complex goods descriptions take longer. The bank will screen the beneficiary and any intermediary parties against international sanctions lists, and compliance checks for certain countries or industries can extend the timeline significantly.
If approved, the bank finalizes the legal terms and prepares a separate reimbursement agreement. This is the contract between you and the bank spelling out your obligation to repay it after it honors a draw. If the beneficiary presents compliant documents and the bank pays, you owe the bank that money regardless of whether the goods arrive in the condition you expected. Your dispute with the seller does not release you from your obligation to the bank.
Issuance and Notification to the Seller
After approval, the issuing bank transmits the letter of credit through the SWIFT network using the MT 700 message type, the standardized format for issuing documentary credits.6Swift. Category 7 – Documentary Credits and Guarantees/Standby Letters of Credit Message Reference Guide The MT 700 carries the credit’s terms, conditions, required documents, and deadlines in a structured format the receiving bank can process immediately.
An advising bank in the beneficiary’s country receives the transmission and verifies its authenticity by checking the digital codes and signatures. The advising bank then notifies the beneficiary that the credit is operative. At that point, the seller can ship the goods knowing that a bank has committed to pay upon presentation of conforming documents. If the credit is confirmed, the confirming bank adds its own guarantee, giving the seller recourse to a local institution if the issuing bank fails to pay.
Know What the Credit Does Not Cover
Letters of credit operate under the independence principle: the bank’s obligation to pay is entirely separate from whatever is happening between the buyer and seller in the underlying deal. If the beneficiary presents documents that comply with the credit’s terms, the bank pays. A dispute over product quality, late delivery, or any other contract issue does not stop payment. The bank examines documents, not goods.
The only exception is fraud. Under UCC Article 5, which governs letters of credit in the United States, a bank may refuse payment if a required document is forged or materially fraudulent, or if honoring the presentation would facilitate a material fraud by the beneficiary.7Legal Information Institute. UCC 5-109 – Fraud and Forgery The bar is deliberately high. A mere suspicion of fraud is not enough, and a routine breach of contract or warranty dispute does not qualify. Courts will issue an injunction stopping payment only where there is evidence of material fraud that undermines the entire transaction. In practice, those injunctions are rare, which is exactly why letters of credit are worth the cost: payment is reliable and predictable once the documents comply.