Letter of Credit (LC): Meaning, Types & Process
Definition
A letter of credit (LC) is a bank's written undertaking, issued on behalf of a buyer, to pay the seller a stated amount once the seller presents documents that comply exactly with the LC's terms within the time allowed.
| Term | Letter of credit (LC) |
|---|---|
| In Hindi | साख पत्र (लेटर ऑफ क्रेडिट) |
| Area | Business |
| Search phrase | letter of credit |
| Try it | Incoterms |
साख पत्र (लेटर ऑफ क्रेडिट) — हिंदी में अर्थ
साख पत्र (LC) खरीदार की ओर से बैंक का लिखित वचन है कि विक्रेता द्वारा तय समय में LC की शर्तों से पूरी तरह मेल खाते दस्तावेज़ प्रस्तुत करने पर बैंक उसे निर्धारित राशि का भुगतान करेगा।
How an LC works
1. Buyer and seller agree payment by LC in the contract. 2. The buyer's bank (issuing bank) opens the LC in the seller's favour. 3. The seller's bank (advising bank) checks and passes it on. 4. The seller ships and presents the required documents — invoice, packing list, transport document such as bill of lading or lorry receipt, insurance and inspection certificates. 5. If the documents comply, the bank pays at sight or on the due date.
Banks deal in documents, not goods. A spelling mismatch, a late shipment date or a missing certificate is a 'discrepancy' that lets the bank refuse payment. International LCs are usually subject to the ICC's UCP 600 rules.
Common types
Sight LC (paid on presentation) and usance LC (paid after a credit period, e.g. 90 days from the bill of lading date). Confirmed LC — a second bank in the seller's country also guarantees payment. Irrevocable — cannot be changed without all parties' consent; the norm today. Inland LC — between Indian buyer and seller, common when an MSME supplies a large company. Back-to-back, revolving and standby LCs serve special cases.
Example
A Ludhiana forging unit supplies ₹40 lakh of parts to a Chennai OEM under a 90-day usance inland LC. After dispatch it presents the tax invoice, e-way bill copy and lorry receipt to its bank, and can discount the accepted bill to get cash early instead of waiting 90 days.
Related tools and guides
Frequently asked questions
What is a letter of credit in simple words?
A bank's promise to pay the seller on behalf of the buyer, provided the seller submits the agreed documents on time.
What is the difference between sight and usance LC?
Sight LC pays as soon as compliant documents are presented; usance LC pays after an agreed credit period.
What is a discrepancy in an LC?
Any mismatch between the presented documents and the LC terms. It allows the bank to refuse payment unless the buyer waives it.
Is an LC the same as a bank guarantee?
No. An LC is the normal way to pay for a trade; a bank guarantee pays only if the applicant fails to perform.
Related terms
- Capex vs opexCapex (capital expenditure) is money spent on long-term assets such as machinery or buildings; it is capitalised and depreciated. Opex (operating expenditure) is the day-to-day cost of running the business — wages, power, rent — and is charged to profit in the year.
- Incoterms (EXW, FOB, CIF, DDP)Incoterms are standard trade terms published by the International Chamber of Commerce that set out, for a sale of goods, who arranges and pays for transport, insurance and customs, and the point at which risk passes from seller to buyer.
- MSME (Micro, Small and Medium Enterprises)MSME stands for Micro, Small and Medium Enterprises. From 1 April 2025 an enterprise is micro up to ₹2.5 crore investment and ₹10 crore turnover, small up to ₹25 crore and ₹100 crore, and medium up to ₹125 crore and ₹500 crore.