A letter of credit (LC) is one of the most important instruments in international trade. It is a guarantee from the buyer's bank to the seller: "If you ship the goods and present the correct documents, we will pay you — regardless of whether the buyer pays us."
Here is how it works: An Indian importer wants to buy machinery from Germany. The importer's bank (issuing bank) opens an LC in favor of the German exporter. The exporter ships the goods, presents shipping documents to their bank (advising bank), and gets paid. The bank bears the payment risk, not the seller.
LCs handle trillions of dollars in global trade annually. They come in several types: irrevocable (cannot be changed without all parties' consent), confirmed (a second bank adds its guarantee), and standby (used as a backup payment mechanism). LC fees typically range from 0.5% to 3% of the transaction value.