September 10, 2026

How a Letter of Credit Actually Works (and Where It Goes Wrong)

An ornate carved stone column capital on a classical bank building facade, representing the issuing bank at the centre of a letter of credit

Your supplier asks for an LC. Your bank asks for documents. Somebody mentions UCP 600. And at no point does anyone explain what is actually happening or where your money is at each stage.

A letter of credit is not complicated once you see the shape of it. But it behaves in one way that surprises almost every first-time user, and that surprise is expensive.

What an LC actually is

A letter of credit is your bank's promise to pay your supplier, given on your behalf, provided the supplier presents a specific set of documents that match the terms you set.

That is the whole idea. Your supplier no longer has to trust you; they have to trust your bank. And you no longer have to send money to a stranger in another country before you have any evidence they shipped anything.

It replaces the buyer's credit risk with the bank's. That is what you are paying for.

Note that in Bangladesh you cannot open one without being a registered importer, so the Import Registration Certificate comes first.

The parties involved

Four roles, and it helps to name them properly because your bank will use these words.

Applicant — you, the importer. You apply for the credit
Issuing bank — your bank in Bangladesh, which issues the LC and carries the payment obligation
Beneficiary — your supplier in China, who gets paid
Advising bank — a bank in China that passes the LC to the supplier and confirms it is genuine

Sometimes the advising bank also confirms the credit, meaning it adds its own guarantee alongside your bank's. Suppliers occasionally insist on this when they are unfamiliar with the issuing bank or the country. It costs more, and the cost usually lands on somebody in the negotiation.

How it moves

The sequence is worth holding in your head, because every dispute traces back to a specific step in it.

You agree terms with your supplier and apply to your bank. Your bank issues the LC and requires a margin — a deposit against the value, the size of which depends on your bank and your relationship with it — plus its charges. The LC travels to the advising bank, which passes it to your supplier.

Your supplier then ships the goods and assembles the documents the LC demands: typically the bill of lading, commercial invoice, packing list, certificate of origin and whatever else you specified. They present that set to the bank.

The bank examines the documents. If they comply, payment is made or committed. The documents come to you, and you need them to clear your goods — our guide to the documents you need to clear customs covers what customs will want from that same set.

The rule that surprises everyone

Here is the part that catches people, and it is not a loophole — it is the entire design.

Under UCP 600, the international rulebook published by the International Chamber of Commerce that governs almost all letters of credit, banks deal in documents, not in goods. Article 5 states this directly. A bank examines whether the documents appear on their face to comply with the credit. It does not inspect your cargo, and it has no obligation to.

The consequence is blunt: if the documents comply, the bank must pay, even if the goods are defective, wrong, or not what you ordered.

This is why an LC is not a quality guarantee. It protects you against a supplier taking your money without shipping. It does not protect you against a supplier shipping rubbish with perfect paperwork. That distinction is exactly the position described in our guide to what to do when goods arrive wrong — the bank has paid correctly and your dispute is entirely with your supplier.

If you want protection on quality, it has to come from somewhere else: an inspection certificate written into the LC as a required document, or a pre-shipment inspection you commission yourself.

Discrepancies: where LCs actually fail

In practice, most LC trouble is not fraud. It is paperwork that does not match.

A bank has a maximum of five banking days following presentation to decide whether the documents comply — that is Article 14(b). If it finds a discrepancy, it issues a single refusal notice listing what is wrong.

Discrepancies are usually small and stupid. A description on the invoice that does not match the wording in the LC. A shipment date a day past the latest date allowed. A bill of lading marked in a way the credit did not permit. A missing signature. A spelling of the consignee that differs between two documents.

When documents are discrepant, the payment obligation falls away and the situation becomes a negotiation. You can waive the discrepancy and instruct the bank to pay anyway, which importers frequently do because the goods are already on the water and refusing achieves nothing. But notice what has happened: at that moment your protection has evaporated and you are back to trusting the supplier.

The practical lesson is to keep the LC terms as simple as your bank and your supplier will accept. Every extra condition you write in is another thing that can be presented incorrectly.

Sight or usance

Two common structures, and the difference is when you pay.

A sight LC pays on presentation of complying documents. The supplier gets their money quickly; you fund it at that point
A usance or deferred LC pays at a defined future date — a set number of days after shipment or after presentation. You get a credit period; the supplier waits, or discounts the draft with their bank to get paid sooner

Suppliers price the two differently, and reasonably so. A usance LC is a form of credit you are asking them to extend, and it will usually be reflected in the unit price.

What to actually do

Agree the document list with your supplier before the LC is issued. Send them the draft. A supplier who reads it and flags a term they cannot meet has saved you an amendment fee and a delay
Keep the terms minimal. Ask for what you genuinely need and no more
Check the dates. Latest shipment date and expiry date must give your supplier realistic room, especially around Chinese holiday shutdowns
Match the goods description exactly. It should read identically on the LC and on the invoice, word for word
Budget for amendments. They are common and they cost money each time
Do not treat the LC as your quality control. If quality matters, put an inspection certificate in the required documents, or arrange your own pre-shipment inspection

An LC is a good instrument for what it does. It moves the payment risk off your supplier's shoulders and onto a bank, which is precisely what lets two parties who have never met trade a container of goods across a border.

Just be clear about what it is buying you. It is a payment mechanism, not an assurance that the thing in the box is the thing you ordered.

Bank charges, margin requirements and permissible LC terms vary between banks and change over time, so confirm the current position with your own bank before you commit to terms with a supplier.

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