A letter of credit replaces your supplier's trust in you with their trust in a bank. That is the entire idea, and everything else is administration.
The supplier does not have to believe you will pay. They have to believe that a bank, having given a written undertaking, will pay against documents. For a first transaction between parties on different continents with no shared legal system, that substitution is worth a great deal.
The mechanics
A documentary credit involves four parties:
- Applicant — you, the buyer.
- Issuing bank — your bank, which gives the undertaking.
- Beneficiary — the supplier.
- Advising / confirming bank — a bank in the supplier's country that authenticates the credit and, if it confirms, adds its own undertaking.
The sequence:
- You and the supplier agree terms, including exactly which documents will trigger payment.
- You apply to your bank, which issues the credit and transmits it to the advising bank.
- The supplier receives the credit and checks it. This is the step suppliers take seriously and buyers often do not.
- The supplier ships and assembles the required documents.
- Documents are presented to the bank.
- The bank examines them against the credit terms.
- If they comply, the bank pays. Documents are released to you, and you use them to claim the goods.
The rule that governs everything
Letters of credit operate under the UCP 600, the ICC's Uniform Customs and Practice for Documentary Credits. One principle drives all outcomes:
Banks deal in documents, not in goods.
The bank does not inspect your cargo. It does not know or care whether the container holds the right product. It examines whether the documents presented match the credit's terms.
Two consequences follow, and both surprise first-time users:
Compliant documents get paid even if the goods are wrong. If the credit calls for a bill of lading, invoice, and packing list, and all three are in order, the bank pays — regardless of what actually shipped.
Non-compliant documents do not get paid even if the goods are perfect. A misspelled company name, a date one day outside the presentation window, a description that differs from the credit wording — any of these is a discrepancy, and the bank is entitled to refuse.
Industry estimates have long put first-presentation discrepancy rates somewhere between half and three-quarters of all presentations. This is not rare. It is the normal case.
Which documents to require
This is your real leverage, and where most of your attention should go. The credit should call for documents that are hard to produce unless the supplier has actually done what you want.
Standard set:
- Commercial invoice, with a goods description matching the credit exactly.
- Full set of clean on-board bills of lading, consigned to order and blank endorsed. "Clean" means no notation of damage. "On board" means actually loaded, not merely received.
- Packing list.
- Certificate of origin, which you will need for duty purposes anyway.
- Insurance certificate, if the term requires the seller to insure.
The one worth adding:
- A pre-shipment inspection certificate from a named independent inspection company, confirming the goods conform to a stated specification.
This is what closes the "documents not goods" gap. Without it, the credit guarantees only that something shipped. With it, an independent third party must certify that the right thing shipped before the supplier can be paid.
Suppliers sometimes resist, because it hands a payment trigger to a third party. That resistance is itself informative.
Confirmed or unconfirmed
An unconfirmed credit carries only the issuing bank's undertaking. If your bank is small, unfamiliar internationally, or based in a market the supplier's bank considers high-risk, the supplier may not regard that undertaking as good enough.
A confirmed credit adds a second undertaking from a bank in the supplier's country. The supplier now looks to a local bank they know.
For African importers this matters practically. Many overseas suppliers will require confirmation for credits issued by banks in markets they do not know well. Confirmation costs more — the confirming bank charges for taking the risk — but if it is what makes the transaction possible, it is not really optional.
What it costs
Charges vary by bank, market, and your relationship, but expect roughly:
- Issuance: commonly around 0.5–1.5% of value per annum, pro-rated to the credit's tenor, often with a minimum fee.
- Confirmation: a further charge reflecting country and bank risk. This varies widely.
- Amendment: a flat fee per amendment. Amendments are common and each one costs.
- Discrepancy fee: charged when documents are refused. Typically a fixed sum, and it comes out of the supplier's proceeds or yours depending on terms.
- Negotiation, advising, and courier charges.
There is also a cost that does not appear on the schedule: your bank will usually require cash cover or a credit line for the full value. Cash margin is working capital frozen for the life of the credit. For many SMEs this is the real reason an LC is unaffordable — not the fees, but the tied-up cash.
Regional practicalities
Nigeria. An LC is opened through an authorised dealer bank, and the Form M process is bound up with it — the Form M must be in place, and the LC and Form M must agree. FX availability has historically been the binding constraint rather than the bank's willingness, so confirm with your bank how and when foreign currency will actually be sourced. Get that in writing before you commit to a supplier deadline.
Ghana. Standard documentary credit practice through commercial banks, with the usual requirement that documents align to what ICUMS will need at clearance.
Kenya. Widely used, particularly for machinery and higher-value consignments through Mombasa. Ensure the credit requires the PVoC certificate where the goods are regulated — otherwise you can end up with a compliant presentation and goods that cannot legally enter.
South Africa. A deep, mature trade finance market with more competitive pricing than most of the continent. If you have a choice of issuing jurisdiction within a group, this matters.
The discrepancy problem, and how to avoid it
Since most presentations are discrepant on first pass, the practical skill is prevention.
Send the supplier a draft credit before issuance. Let them confirm they can produce every document exactly as worded. Amendments after issuance cost money and time; a draft review costs nothing.
Keep the goods description short. A long, detailed description in the credit creates many opportunities for a mismatch. UCP 600 requires the invoice description to correspond to the credit; a terse description is easier to match. Put the detailed specification in the inspection certificate requirement instead.
Check names and addresses character by character. A supplier's legal name differing from their trading name is a classic discrepancy.
Set a realistic presentation period. The default is 21 days after shipment. If your supplier's chain of documents — especially a certificate of origin from a chamber of commerce — routinely takes longer, extend it at issuance.
Match the latest shipment date to real lead times, with slack. Missing it makes every subsequent document discrepant regardless of quality.
The main variants
Sight credit. The bank pays as soon as compliant documents are presented. Simplest, and what "letter of credit" means unless stated otherwise.
Usance / deferred payment credit. Payment falls due a set period after presentation or shipment — commonly 30, 60, 90, or 180 days. This is the version that actually finances you, because you receive the goods before you pay.
Transferable credit. Allows the beneficiary to transfer all or part of the credit to a second beneficiary. Used when your supplier is an intermediary sourcing from the actual manufacturer. Worth knowing about, because a supplier asking for a transferable credit is telling you they are not the producer.
Back-to-back credit. Two separate credits, where an intermediary uses your credit as security to open a second one to their own supplier. Common in commodity trading and a signal of the same intermediary structure.
Revolving credit. Automatically reinstates after each drawing, up to a limit. Useful for regular repeat shipments with the same supplier, because it avoids the cost and delay of re-issuing every time.
Standby credit. Functions as a guarantee rather than a payment mechanism — it is drawn only if you fail to pay by the agreed route. Closer in spirit to a bank guarantee than to a documentary credit.
For a first-time importer, a confirmed sight credit is the usual starting point. Once you have a relationship and want the working-capital benefit, a usance credit is the natural next step.
Reading a credit when it arrives
Your supplier will check the credit carefully. You should too, because errors originate in your own application and amendments cost money.
Check specifically:
- Beneficiary name and address, exactly as the supplier's documents will show them.
- Amount and tolerance. If quantities may vary, ensure the credit permits it — a "10% more or less" tolerance is standard for bulk goods.
- Latest shipment date and expiry date. The expiry must leave room for document presentation after the last possible shipment.
- Presentation period. 21 days is the default; confirm it is achievable given how long your supplier's certificate of origin takes.
- Partial shipments and transhipment. If your route requires transhipment — very common into African ports — the credit must allow it, or the bill of lading will be discrepant.
- Port of loading and discharge, matching what will actually happen.
- The document list, word for word against what the supplier can produce.
Transhipment is the one that catches African importers most often. Many services into Tema, Mombasa, or Apapa tranship through a hub port. A credit prohibiting transhipment on such a route guarantees a discrepancy.
When an LC is the wrong instrument
Small orders. Below roughly $20,000–30,000, the fees, cash cover, and administrative effort rarely justify themselves. Escrow gives you most of the protection at a fraction of the cost and complexity.
Established suppliers. Once you have a track record, open account terms are cheaper and faster for both sides. Continuing to use an LC with a supplier you have used twenty times is paying for a problem you no longer have.
Fast-moving goods. The document cycle adds time. If you need goods in three weeks, the LC process may not fit.
When you cannot afford the cash cover. This is the honest constraint for most SMEs, and it is not a failure — it is a reason to look at escrow, or at the trade finance instruments designed for exactly this gap.
The short version
Use a letter of credit when the order is large enough to matter, the supplier is new enough not to trust, and you can afford the cash cover. Require an independent inspection certificate as one of the documents. Have your supplier review the draft before issuance. And remember throughout that the bank is checking paperwork, not cargo — the inspection certificate is the only thing in the whole structure that looks at the goods.