Opening a Letter of Credit starts with your bank issuing a documented payment guarantee on your behalf, based on agreed terms with your supplier, which the supplier’s bank confirms before the LC becomes active. This is a more involved process than a simple bank transfer, with specific steps and documentation requirements worth understanding before your first order using this payment method.
Step 1: Agree terms with your supplier first
Before approaching your bank, you need finalized terms with your supplier — product specification, price, quantity, Incoterm, and shipping timeline — typically documented in a proforma invoice. The LC will be built around these exact terms, so ambiguity here becomes ambiguity in the LC itself.
Step 2: Apply to your bank (the issuing bank)
Submit an LC application to your own bank, known as the issuing bank in this transaction, including the agreed terms, the supplier’s bank details, and any specific documentation requirements you want built into the LC’s conditions. Your bank will also assess your creditworthiness and may require collateral or a deposit, depending on your banking relationship and the LC value.
Step 3: The issuing bank sends the LC to the supplier’s bank
Once approved, your bank transmits the LC to the supplier’s bank, known as the advising or confirming bank, which reviews and notifies the supplier that the LC has been established in their favor. At this point the supplier has a documented, bank-backed payment guarantee, conditional on them meeting the LC’s stated terms.
Step 4: The supplier ships and submits documents
The supplier ships the goods and submits the required documentation — commercial invoice, packing list, bill of lading, certificate of origin, and any other documents specified in the LC — to their bank, which checks these documents against the LC’s exact terms.
Step 5: Document review and payment release
If the submitted documents match the LC’s terms precisely, payment is released to the supplier through the banking chain. If there’s a discrepancy — even a minor one, like a date mismatch or a missing signature — the LC can be held pending resolution, which is why document accuracy on the supplier’s side matters enormously to actually getting paid on time.
Why LCs protect both sides, not just the buyer
An LC gives the supplier a bank-backed payment guarantee rather than relying purely on buyer trust, while giving the buyer assurance that payment only releases once the agreed documentation confirms the shipment happened as specified. This is precisely why LCs are common for new trade relationships without an established trust history, even though they add more process than a simple wire transfer.
