What Is Letter of Credit?

With an LC, the buyer asks its bank to issue a document promising payment to the seller. The seller ships the goods and presents the documents named in the LC, such as the invoice and transport document. If the documents match the LC terms, the bank pays. If they do not match, the bank may refuse. So the exporter's main task is to follow the LC terms exactly. LCs usually carry bank charges and take time to arrange. Exporters read each term carefully on receipt and ask for changes before shipping, not after.

For example, an Indian exporter agrees to sell machine parts to a buyer in Spain. The buyer's bank issues an LC for EUR 30,000. The exporter ships, presents matching documents, and the bank pays.

• Payment security: The bank's promise gives the seller comfort beyond the buyer's own promise, as long as the documents match the LC terms.
• Bank compliance: The 2026 regulations refer to LCs in two places. Regulation 13 mentions an irrevocable Letter of Credit for unrealised exports, and Regulation 12(2) mentions a standby Letter of Credit or guarantee for importers with unrepatriated advances.
• Costs: Banks charge fees for issuing, advising and confirming LCs. Ask your AD bank for its charges, as they vary.
• Realisation: Payment under an LC is still export proceeds. It is recorded against the export in the usual way by the AD bank.

An LC runs between the buyer, the buyer's bank, the seller's bank and the seller. Payment depends on documents, not on the buyer's later wish to pay.

1. The buyer and seller agree on payment by LC in the sales contract.
2. The buyer asks its bank to issue the LC in the seller's favour.
3. The seller's bank advises the seller of the LC.
4. The seller checks the terms and asks for amendments if needed.
5. The seller ships the goods and presents the required documents to its bank.
6. The banks check the documents against the LC and pay if they comply.

Check every LC term against your contract and your ability to meet it before you ship. Most refusals come from documents that do not match the LC.

1. Ask the buyer for a draft of the LC terms before the order is confirmed.
2. On receipt, compare the amount, goods description, shipping dates and documents with your contract.
3. Ask for an amendment if any term cannot be met.
4. Prepare each document exactly as the LC describes.
5. Present documents to your bank within the time the LC allows.
6. Keep copies of everything and note the payment date for your bank records.

• Guaranteed payment: Payment depends on compliant documents, so a small mismatch can lead to refusal.
• Buyer's bank only: The seller's bank is also involved, since it advises the LC and handles the documents.
• Same as advance: An LC is a bank promise to pay later. An advance is money paid before shipment.
• Free service: Banks charge fees for LCs, which the contract should allocate.

• Advance remittance: Payment sent before goods or services are delivered.
• Export realisation: Receipt of export payment through an AD bank.
• Inward remittance: Money received in India from abroad.
• Merchanting trade: Buying from one foreign party and selling to another.

Every rule and definition on this page is linked to its official source, checked on the dates below.

1. FEMA (Export and Import of Goods and Services) Regulations, 2026, Notification FEMA 23(R)/2026-RB, Regulation 12(2) and Regulation 13 (checked 9 Oct 2026)