A Letter of Credit Tests Documents, Not Goods

What the Bank Actually Promises

A documentary credit is an undertaking by a bank to pay a stated amount against documents that comply with the terms of the credit. The undertaking stands apart from the sale contract. If the documents comply, the bank pays even when the goods are late, wrong, or never shipped. If the documents do not comply, the bank does not pay even when the goods are perfect and already sitting in your warehouse.

Both halves of that sentence cost buyers money. A first-time importer imagines the credit protects them against a bad supplier. It does not, beyond the documents a carrier or an inspector signs. A first-time exporter imagines that shipping the right goods is enough. It is not, if the bill of lading names the wrong notify party.

What the credit does buy is a change of counterparty. For the supplier, the risk of your non-payment becomes the risk of a bank not paying. That is why a factory that refuses a 30 percent deposit on a first order will usually accept a credit: not because they trust you more, but because they no longer have to.

Four Parties, Two of Which Do the Work

The applicant is you. The beneficiary is the supplier. The issuing bank is yours, and it takes the credit risk and the cash margin. The advising bank is the supplier's, and it authenticates the credit and usually handles presentation.

Two optional parties change the cost. A confirming bank adds its own payment undertaking on top of the issuing bank's, which matters when the issuing bank is in a country your supplier's bank does not want exposure to. A nominated bank negotiates or pays, and charges for it.

For a Chinese supplier the chain is usually short: your bank issues, a Chinese bank advises, the credit is available with any bank by negotiation or sight payment. The supplier's finance department will read three fields first, because those decide whether they can get money this month: the amount, the latest shipment date, and whether partial shipment is allowed.

The Documents Are the Contract

Every document is checked against the credit text and against every other document. The usual set:

• Commercial invoice. The goods description has to match the credit wording, not an improved version of it. If the credit says stainless steel bottle 500 ml, an invoice saying insulated flask 17 oz is a discrepancy.
• Packing list. Quantities, carton count and weights consistent with the invoice and with the transport document.
• Transport document. On board, clean, full set, correctly consigned, freight prepaid or collect exactly as the credit states.
• Certificate of origin. The form has to be the one the credit names, issued by the body it names.
• Insurance certificate. Required under CIF and CIP, in the currency of the credit, for the percentage stated, dated no later than the shipment date.
• Inspection or beneficiary certificate. Where the credit asks for one, the wording matters more than the finding.

Inconsistency between two documents is a discrepancy even when both are individually correct. That single rule accounts for a large share of refusals.

Why First Presentations Get Refused

Refusal is normal on a first presentation, and the causes repeat.

• Description drift. The invoice paraphrases the credit instead of copying it.
• Late shipment. The on board date on the bill of lading falls after the latest shipment date, often because the booking slipped a week and nobody told the buyer.
• Late presentation. Documents arrive after the presentation period, which defaults to 21 calendar days from shipment when the credit is silent, and always inside the expiry date.
• Partial shipment. Two lots shipped when the credit prohibits partial shipment, usually because the factory filled the container in two runs.
• Freight status. Prepaid shown where the credit says collect, or the reverse.
• Insurance dated after shipment. The certificate must not post-date the transport document.

The practical defence costs nothing. Before couriering, send scans to the advising bank and ask for a pre-check against the credit. Banks do this routinely, and a discrepancy found on a screen is free while one found at examination carries a fee and a delay of a week.

Where the Cost Accumulates

The headline commission is rarely the whole bill. A credit generates charges at four or five points:

• Issuance commission. A percentage of the credit value charged per quarter or per month of validity, with a minimum. A credit left open for four months costs more than one open for six weeks, for the same goods.
• Cash margin. Your bank will hold a deposit against the facility, often the full value for a first-time importer. That is working capital tied up for the life of the credit, and it is the largest real cost for most small buyers.
• Advising and confirmation. Charged by the supplier's bank, sometimes to you under the credit terms. Confirmation is the expensive half.
• Amendments. Every change after issuance is billed, usually to whichever side asked. Change the quantity twice and the amendment fees become visible.
• Discrepancy and negotiation fees. Levied per set of documents, whether or not the discrepancy is waived.

Ask your bank for a full quote that includes amendment and discrepancy charges rather than the issuance rate alone, then compare the total to the order value. On a container of consumer goods the fees are a line item. On a trial order of a few thousand dollars they can exceed the freight.

The Clock, From Application to Payment

A credit is not a same-week instrument. Application and approval take days, not hours, and the timeline has to fit around a production schedule that is already running.

Budget three to ten business days for your bank to approve and issue, depending on whether the facility already exists and whether a margin has to be funded. Advising takes another one to three days. The shipment then has to fall inside the window, and documents must be presented inside the presentation period and before expiry.

After presentation the bank has up to five banking days to examine and decide. A sight credit pays on acceptance. A usance credit pays 30, 60 or 90 days later, which is how a supplier finances your order and prices it accordingly.

The working rule: if the goods must sail in three weeks, the credit has to be applied for now, and the latest shipment date has to be set with slack for a rolled booking. A credit whose shipment date matches the production finish date will be amended, and amendments cost money and time in that order.

When an LC Is the Wrong Instrument

Four situations where the mechanics cost more than the protection returns.

A trial order small enough that the fees and the blocked margin are a meaningful share of the goods value. A sample order paid on a card. A supplier you have bought from for two years, where the relationship is the security and an inspection before the balance is the control. And any order where the real risk is quality rather than payment, because a credit says nothing about quality that an inspection certificate does not already say.

There is also a misconception worth killing. A credit does not verify a supplier. It moves the payment risk to a bank and leaves the performance risk exactly where it was. If the factory cannot produce, the credit expires and you have lost the season rather than the money.

What to Use Instead

The common alternative for a Canton Fair first order is 30 percent deposit against a proforma invoice and 70 percent before shipment, with a third-party inspection released before the balance. The inspection, not the payment split, is what protects the buyer; the split only limits exposure.

Documentary collections are cheaper than credits and weaker. Under documents against payment the bank hands over the transport document only when the buyer pays, but no bank undertakes to pay, so a supplier who ships and is refused has a container at the destination and a bill.

For repeat business, open account terms with credit insurance transfer the default risk for a premium and remove the per-order fees. For performance rather than payment, a standby credit or a bank guarantee does the job a commercial credit cannot.

What all of them share is a document trail. Whoever arranges the shipment has to issue documents that match what the payment instrument demands, and that is a conversation to have before the goods are packed, not after.

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