Letter of credit It is often seen as a “traditional” financial instrument in foreign trade. But, in practice, it is a governance tool: it defines how risk, timeframes, and compliance will be managed between buyer, seller, and banks in an international transaction.
For management, the real value lies not only in guaranteeing payment. It lies in creating predictability and reducing exposure in environments where logistics, documentation, and regulation can fail. In global supply chains, letters of credit become even more relevant when there is high logistical variability, new suppliers, markets with higher perceived risk, or transactions with higher unit value.
What many companies underestimate is that this tool is not "just a financial matter." It depends directly on the operational and documentary execution of the shipment.
What is a letter of credit and why is it still relevant today?
In short, letter of credit A letter of credit (L/C) is a commitment from the importer's bank to pay the exporter, provided the exporter presents documents that exactly meet the stipulated terms and conditions. The most widely used international standard is... UCP 600, published by the International Chamber of Commerce, which establishes uniform rules and practices for the use of documentary letters of credit.
The key point is that banks deal with documents, not goods. This creates a particular logic: the exporter may have delivered correctly, but if there is a discrepancy in the documentation, payment may be delayed or rejected until the importer accepts the discrepancy.
Essential components and how structure influences risk.
One of the letter of credit It involves, at a minimum:
- importer (applicant);
- exporter (beneficiary);
- Issuing bank (of the importer);
- advising bank (in the exporter's country).
In operations with greater riskThere may be a confirming bank, which adds its own payment guarantee to the exporter. The choice of confirmation alters cost and risk appetite, but it can be decisive in enabling negotiations with strategic suppliers.
Another relevant structural point is the type of letter of credit:
- Cash payment: payment occurs after presentation and verification of documentation, within the deadline;
- On credit: payment occurs at a future date, creating an effect similar to financing.
Management needs to assess the effect on working capitalA term L/C (Letter of Credit) can extend payment terms, but it can also increase costs and require guarantees.
Where letters of credit “break down”: documentary discrepancies
The main flaws in letter of credit These discrepancies don't usually happen at the bank level—they happen in the document chain. Discrepancies include:
- Inconsistent dates (departure, issuance, presentation);
- Description of goods different from what is required;
- Missing or non-standard documents;
- inconsistencies in weights, volumes and brands;
- Bill of lading with prohibited clauses.
There is consistent evidence that documentary discrepancies are common in letter of credit transactions, especially when there is logistical complexity and multiple parties involved.
O ICC Trade Register ReportThis publication, based on data from participating banks, is a benchmark for risk analysis in trade finance instruments and highlights the importance of quality documentation in mitigating risk.
For management, this means that a letter of credit can reduce counterparty risk, but it can introduce operational risk if the company does not have... governance mature documentary.
Intersection between letter of credit and international logistics
The least discussed (and most critical) element is that the logistic performance determines the financial performance of the instrument.
Shipping deadline and submission deadlines
Letters of credit have rigid windows: latest shipping date, deadline for submitting documents, and validity period. If logistics are delayed, the exporter may lose eligibility and the importer may have a supply problem.
Bill of lading and document control
The bill of lading (B/L) is usually the central document. Errors in issuance, consignee variations, or route and transshipment changes can generate discrepancies. Furthermore, depending on the Incoterm and delivery structure, document control determines who can release the cargo.
Indirect costs of delay
When there is a discrepancy and payment is delayed, the cargo may be held up, generating costs such as storage, demurrage, and production rescheduling. The financial instrument can then become an additional total cost.
Hence, letter of credit It needs to be treated as an operational contract, not just a banking contract.
Brazil: Exchange rate governance and regulatory aspects
In Brazil, credit letters They connect to the foreign exchange ecosystem and the compliance practices of banks and companies. The structure of international payments, registration, and foreign exchange rules is overseen by the Central Bank. The consolidation of the new foreign exchange legal framework (Law 14.286 / 2021) reorganized guidelines for the foreign exchange and international capital markets, with impacts on practices and processes.
Although the law does not specifically address letter of credit As an isolated instrument, it is relevant because it influences the regulatory and operational environment in which foreign trade operations and international payments are executed in Brazil.
For management, the concrete impact is that the design of the financial flow, deadlines, and documentary requirements must be aligned with the internal compliance policy, the financial institution, and the logistical reality.
How to decide if using a letter of credit makes sense
Management can use practical logic to decide when to letter of credit adds value:
- When counterparty risk is relevant: new supplier, new market, limited track record, or high-value transactions.
- When the operation requires governance and predictabilityCritical goods, long-term contracts, need for standardized documentation.
- When a negotiation needs a secure anchor: a letter of credit can unlock better terms, including price and payment terms.
- When it doesn't make sense: in mature supply chains with a high level of trust and good document governance, simpler models may have a lower cost.
The ICC publishes definitions and guidelines about supply chain finance and trade finance techniques that help structure instrument decisions by context.
Practical recommendations for reducing execution risk.
Some simple adjustments drastically reduce discrepancies and delays:
- Standardize product descriptions and nomenclature before issuance.
- Review critical terms: departure window, required documents, submission deadline.
- Train the team and partners on the bank's documentation criteria.
- Create a document review workflow before the presentation.
- Align logistics and finances: operational deadlines need to fit within financial deadlines.
The goal is not to create bureaucracy: it's to reduce the cost of exceptions, which always arise during the most critical moments.
Conclusion
Letter of credit It remains a fundamental tool for international operations, especially when the goal is to reduce counterparty risk and increase predictability. But it only delivers this value when the company treats documentation and logistics as part of the same risk architecture.
For management, the most important question is not "which bank issues it," but rather "can our operation consistently meet the requirements of the instrument?" When the answer is yes, the letter of credit ceases to be a cost and becomes a lever for negotiation and governance.
Learn more about us Cargo Sapiens Discover how data and predictability in international freight contracting help reduce operational exceptions that generate costs and risks in structured letter-of-credit operations.
