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Letter of credit:
what it is and how it works.
A letter of credit is a bank's guarantee of payment to a seller, used widely in international trade to remove the risk of non-payment. This guide explains how it works, who the parties are, and how it fits alongside working capital finance.
What a letter of credit does
In international trade, a seller is often reluctant to ship goods before receiving payment — and a buyer is reluctant to pay before receiving the goods. A letter of credit breaks this deadlock:
- The buyer asks their bank (the issuing bank) to issue an LC in favour of the seller.
- The LC specifies what the seller must do to receive payment — typically, present specific shipping documents (bill of lading, commercial invoice, packing list).
- The seller ships the goods and presents the required documents to their bank (the advising bank).
- If the documents comply with the LC terms, the issuing bank pays — regardless of whether the buyer has the funds at that moment.
- The buyer repays the issuing bank (often with a credit period).
The result: the seller gets a bank's payment guarantee, not just a buyer's promise. The buyer gets a guarantee that the seller must meet specific conditions (delivery documentation) before being paid.
Types of letter of credit
- Irrevocable LC. Cannot be changed or cancelled without all parties' consent. Provides strong protection to the seller. The standard form in commercial trade.
- Confirmed LC. The seller's bank (the advising bank) adds its own guarantee to the LC, in addition to the issuing bank's. Useful when the seller does not trust the issuing bank's country.
- Standby LC. A secondary guarantee rather than a primary payment mechanism — the bank pays only if the buyer defaults. Functions more like a bank guarantee than a documentary credit.
- Revolving LC. Renews automatically up to a set limit across multiple shipments. Used for ongoing supplier relationships where the same trade terms apply repeatedly.
How to use letters of credit alongside working capital finance
- Decide whether you need an LC or working capital finance. An LC is a payment guarantee for a specific trade transaction — needed when a seller requires bank-backed payment security before shipping. Working capital finance (Credicorp Bridging Loan, Flex) is needed when the company needs cash to fund operations or bridge a timing gap. These are different products for different needs.
- Contact your business bank for an LC. Banks with trade finance desks — Barclays, HSBC, NatWest, Lloyds — issue letters of credit. They will assess your creditworthiness, require security, and charge a fee for issuing the LC.
- Use Credicorp for short-term cash flow needs that arise during the trade cycle. While a trade transaction is in progress — goods in transit, waiting for customer payment — a Credicorp Business Bridging Loan or Flex facility can fund overheads, payroll, or a deposit on the next shipment. Apply at credicorp.co.uk.
- If you are the seller under an LC, present compliant documents. Payment under an LC is conditional on presenting exact documents. Even minor discrepancies between the documents and the LC terms can allow the bank to refuse payment. Review the LC terms carefully before preparing shipping documentation.
Letter of credit questions
What is a letter of credit?
A letter of credit (LC) is a document issued by a bank on behalf of a buyer, guaranteeing payment to the seller — provided the seller meets specified conditions. It is widely used in international trade to reduce the risk that a buyer fails to pay. The bank, not the buyer, takes on the payment obligation. The seller is paid by the bank once it presents compliant shipping and trade documentation. The buyer then repays the bank.
Who are the parties to a letter of credit?
There are four main parties: (1) the applicant (the buyer) — who asks their bank to issue the LC and is ultimately responsible for repaying the bank; (2) the issuing bank — the buyer's bank, which issues the LC and guarantees payment; (3) the beneficiary (the seller) — who receives payment under the LC provided the conditions are met; (4) the advising/confirming bank — the seller's bank, which notifies the seller of the LC and, if confirming it, adds its own payment guarantee.
What is the difference between a revocable and irrevocable letter of credit?
A revocable LC can be modified or cancelled by the issuing bank without the seller's consent — providing very little protection to the seller. An irrevocable LC cannot be changed or cancelled without the agreement of all parties, including the beneficiary. In practice, virtually all commercial letters of credit are irrevocable, because only an irrevocable LC provides meaningful payment security to the seller.
What is the difference between a letter of credit and a bank guarantee?
A letter of credit is a primary payment mechanism — the bank pays when conditions are met, and payment is expected to be made. A bank guarantee is a secondary obligation — the bank only pays if the applicant defaults. In trade finance, an LC is used when the seller needs certainty that payment will be made; a guarantee is used when a party needs security against a potential failure, not as the primary payment route.
Does Credicorp offer letters of credit?
No. Credicorp's products — the Business Bridging Loan, Flex, and Slice — are short-term working capital and invoice finance products for UK trading companies, not documentary trade finance instruments. They are designed for businesses that need to bridge a cash flow gap, not for businesses that need to guarantee payment to a foreign supplier. For a letter of credit, you would approach a business bank (Barclays, HSBC, NatWest) that operates a trade finance desk. Credicorp's products can complement trade finance — for example, funding a deposit to a supplier while a LC is arranged — but they are not LCs.
Related guides
For a broader overview of trade finance products, read what is trade finance. For Credicorp's working capital products that can complement trade finance, read Bridge vs Flex vs Slice. For Credicorp's invoice finance product (Slice), read what is invoice finance. All the guides are on the Learn hub.
Need short-term working capital during a trade cycle?
Credicorp bridges cash flow gaps — not letters of credit, but the right complement for trade-cycle timing problems.