What Is an Export Letter of Credit?

An export letter of credit is the designation given by an exporter's bank to the trade document issued on behalf of an importer, guaranteeing payment for goods purchased. In international trade, there are two banks involved in a sales transaction. The issuing bank creates the letter of credit on behalf of the importer, or buyer, and calls it an import letter of credit. On the other side of the transaction, the advising bank is the bank for the exporter, or seller, accepting the letter to process payment from the issuing bank. Advising banks call the letter an export letter of credit.

Letters of credit facilitate international trade and make transactions more secure for both importers and exporters. In a general sense, a letter of credit is much like a certified check, guaranteeing payment by a bank if certain conditions are met in advance so the seller can deliver goods knowing payment is held in escrow by an unimpeachable third party. Once a sales contract is signed between the importer and exporter, the importer takes it to his bank to have a letter of credit issued. The issuing bank refers to the letter as the import letter of credit because it deals with the importing side of the transaction.

An importer typically transfers the letter of credit to the exporter. At this point, the letter exists on the export side of the transaction. The exporter ships the goods and takes the bill of lading and the letter to his bank, the advising bank, for processing. Advising banks refer to the letter as an export letter of credit because the duties it will preform to complete the transaction are exclusively on behalf of the exporter. The advising bank presents the documents to the issuing bank, and accepts the appropriate payment in exchange.

Issuing banks pass the bill of lading received from the advising bank or exporter to the importer, who uses it to claim the goods from the shipping company. An export letter of credit removes the risk of shipping goods and paying money to foreign parties by inserting banks into the transaction to act as an escrow agent. Both the issuing bank and the advising bank are bound by the exact terms detailed in the letter. There is no real possibility that one party can defraud the other by taking payment without shipping goods or taking goods without transferring payment.