Basic Procedures for Establishing a Letter of Credit

The letter of credit process has been standardized by a set of rules published by the International Chamber of Commerce (ICC). These rules are called the Uniform Customs and Practice for Documentary Credits (UCP) and are contained in ICC Publication No. 500. The following is the basic set of steps used in a letter of credit transaction. Specific letter of credit transactions follow somewhat different procedures.

1. After the buyer and seller agree on the terms of a sale, the buyer arranges for his bank to open a letter of credit in favor of the seller. Note: The buyer will need to have a line of credit established at the bank or provide cash collateral for the amount of the letter of credit.
2. The buyer's issuing bank prepares the letter of credit, including all of the buyer's instructions to the seller concerning shipment and required documentation.
3. The buyer's bank sends the letter of credit to the seller's advising bank.
4. The seller's advising bank forwards the letter of credit to the seller.
5. The seller carefully reviews all conditions stipulated in the letter of credit. If the seller cannot comply with any of the provisions, it will ask the buyer to amend the letter of credit.
6. After final terms are agreed upon, the seller ships the goods to the appropriate port or location.
7. After shipping the goods, the seller obtains the required documents. Please note that the seller may have to obtain some documents prior to shipment.
8. The seller presents the documents to its advising bank along with a draft for payment.
9. The seller's advising bank reviews the documents. If they are in order, it will forward them to the buyer's issuing bank. If a confirmed letter of credit, the advising bank will pay the seller (cash or a bankers' acceptance).
10. Once the buyer's issuing bank receives and reviews the documents, it either (1) pays if there are no discrepancies; or (2) forwards the documents to the buyer if there are discrepancies for its review and approval.

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