LC discounting & letter of credit finance

What a letter of credit actually is

A letter of credit is a bank’s undertaking to pay a seller, provided the seller presents documents that comply with the terms of the credit. It substitutes the buyer’s promise with a bank’s, which is why it exists at all: it lets two parties who do not know each other trade without either taking unacceptable risk.

The essential principle, set out in UCP 600, is that banks deal in documents and not in goods. The issuing bank is not concerned with whether the machinery worked or the fabric was the right shade. It is concerned with whether the bill of lading, the invoice and the certificates match the credit. Understanding that single sentence prevents most LC problems.

For the buyer, an LC is a non-fund based limit: the bank commits its name rather than its money at the outset, and the exposure converts to funded only if payment falls due. For the seller, a usance LC creates a bank-backed receivable that can be discounted — which is where LC discounting comes in.

LC discounting, from the seller’s side

Under a usance LC, the issuing bank accepts your documents and undertakes to pay on a future date. That acceptance is a bank obligation. A bank will discount it and pay you now, less a discount charge, because it is taking bank risk rather than commercial risk.

This is generally the cheapest form of post-shipment finance available to a seller, and the reason many exporters and domestic suppliers push for a usance LC rather than open account terms. The seller gets paid immediately; the buyer still gets their credit period; the cost sits in the discount and the LC charges, split according to whatever the contract says.

The gate is document compliance. If the presentation is discrepant, the issuing bank is entitled to refuse, and there is nothing to discount until the discrepancy is cured or waived by the buyer. At that point you are back to relying on the buyer’s goodwill — precisely the risk the LC was taken out to avoid.

Discrepancies: the whole ballgame

A very large proportion of first presentations under letters of credit are rejected for discrepancies, and the causes are mundane rather than exotic:

• Goods description not matching the credit. The invoice description must correspond to the credit; paraphrasing is not sufficient.
• Late presentation or late shipment — documents presented beyond the presentation period, or shipped after the latest shipment date.
• Inconsistency between documents. Weights, marks, quantities or dates that differ between the invoice, the packing list and the transport document.
• Transport document defects — missing on-board notation, incorrect consignee or notify party, missing endorsement, or a claused bill of lading where a clean one was required.
• Insurance shortfalls — cover below the percentage required, wrong currency, or dated after the shipment date.
• Missing or wrongly issued certificates, where the credit specified who must issue them.

The preventable fix is procedural rather than clever: read the credit in full the day it arrives, not the day you ship. Check every requirement against what you can actually produce, and if something is impossible — a certificate you cannot obtain, a shipment date you cannot meet — request an amendment immediately, while there is still time. Amendments before shipment are routine; discrepancies after shipment are expensive.

From the buyer’s side

Opening an LC requires a non-fund based limit from your bank, assessed alongside your funded working capital limits. The bank is extending its name, so it assesses you much as it would for a loan, and will usually require a margin — a proportion of the LC value held as cash or deposit — plus security.

Costs on the buyer’s side include the LC opening commission, usually charged per quarter or part thereof on the value and tenor, amendment charges, and the bank’s handling fees. On a usance LC, the buyer effectively obtains supplier credit backed by their own bank’s standing, which is often cheaper than borrowing the equivalent working capital directly. That comparison — LC commission plus supplier pricing, against drawing on your cash credit limit — is worth actually calculating rather than assuming.

One discipline matters above all: an LC is an irrevocable commitment by your bank. Once compliant documents are presented, payment will be made whether or not the goods arrived in the condition you expected. Commercial protection comes from the contract, inspection certificates and marine cover, not from refusing payment under the credit.

How Rytvae helps

We help businesses around Bengaluru assess non-fund based limits alongside their funded working capital, structure LC terms that are actually complyable-with, and arrange facilities through our banking partners. See also foreign bill discounting, invoice and bill discounting and working capital loans.

Frequently asked questions