For larger commodity orders, a letter of credit is one of the most powerful payment tools available, but it is also one of the most misunderstood. This guide explains the letter of credit for commodity importers in plain language: what it is, who the parties are, how the documents flow, the main types, how it compares with a wire transfer, the document set banks demand, and why small discrepancies cause expensive delays. It also shows how a buying agent helps your supplier’s presentation match the terms.
What is a letter of credit?
A letter of credit (LC), sometimes called a documentary credit, is a written undertaking by a bank to pay the seller a stated amount, but only when the seller presents documents that comply exactly with the conditions set out in the credit. In effect, the buyer’s bank steps in and substitutes its own creditworthiness for the buyer’s.
This solves the central tension of international trade. The seller does not want to ship goods before being sure of payment; the buyer does not want to pay before being sure of shipment. The LC bridges that gap: the seller is paid against compliant documents, and the buyer’s bank pays only when those documents, which evidence shipment and quality, are in order. It is a stronger instrument than the structures described in our overview of safe payment methods when importing.
Who are the parties to a letter of credit?
An LC involves several roles, and understanding them clarifies the whole process:
- Applicant: the buyer (importer), who asks their bank to open the credit.
- Beneficiary: the seller (the Indonesian supplier), who will be paid under the credit.
- Issuing bank: the buyer’s bank, which issues the LC and carries the payment undertaking.
- Advising bank: a bank in the seller’s country that authenticates the LC and passes it to the seller.
- Confirming bank: an optional bank, often the advising bank, that adds its own guarantee of payment, useful when the seller does not fully trust the issuing bank’s country.
- Nominated bank: the bank authorised to accept and check the documents and pay the seller.
How does the letter of credit document flow work?
The process follows a logical sequence from contract to payment:
- Contract: buyer and seller agree the sale, including price, Incoterm and that payment will be by LC.
- Application: the buyer applies to the issuing bank to open the credit with the agreed terms and required documents.
- Issuance and advising: the issuing bank sends the LC to the advising bank in Indonesia, which authenticates it and notifies the seller.
- Shipment: the seller ships the goods through the Indonesian port that serves their region and gathers the required documents.
- Presentation: the seller presents the document set to the nominated or advising bank.
- Examination: the bank checks the documents strictly against the LC terms.
- Payment: if the documents comply, the bank pays at sight or at the agreed future date, and the documents pass to the buyer, who uses them to clear and collect the goods.
The Incoterm you agree feeds directly into this flow, since it determines which transport documents are required; see our guide to Incoterms for importing from Indonesia for how the two interact.
What are the main types of letter of credit?
LCs vary along a few key dimensions, and you choose the combination that fits the order.
| Type | What it means | When it helps |
|---|---|---|
| Irrevocable | Cannot be changed or cancelled without all parties’ consent | The standard for trade; revocable LCs are effectively obsolete |
| Confirmed | A second bank adds its own payment guarantee | When the seller doubts the issuing bank or country risk |
| Sight | Pays as soon as compliant documents are presented | When the seller wants prompt payment |
| Usance (term) | Pays a set period after presentation or shipment | When the buyer needs credit time to sell on |
| Transferable | Allows the beneficiary to transfer part to another party | Where an intermediary supplier sources from others |
| Revolving | Reinstates automatically for repeat shipments | Ongoing supply under one master arrangement |
Almost all modern trade LCs are irrevocable. The first decision is usually whether to add confirmation, and the second is sight versus usance, which is really a cash-flow decision for both sides.
Letter of credit versus telegraphic transfer
An LC is not always the right tool. It competes with the simpler telegraphic transfer, and each has a place.
| Factor | Letter of Credit | Telegraphic Transfer (staged) |
|---|---|---|
| Payment security | High, bank-backed | Moderate, tied to milestones |
| Cost | Higher (bank fees both sides) | Low |
| Complexity | High, document-driven | Low |
| Speed to set up | Slower | Fast |
| Best order size | Larger | Small to mid-size |
| Risk of delay | Discrepancies can stall payment | Fewer moving parts |
The headline trade-off is security versus cost and effort. An LC gives bank-backed assurance to both parties but adds fees, paperwork and the risk of discrepancy delays. A staged wire is cheaper and faster but rests on milestones and trust rather than a bank guarantee.
What documents does a letter of credit demand?
The LC lists the exact documents the seller must present, and payment hinges on them. A typical commodity LC document set includes:
- Commercial invoice, matching the LC description, value and currency precisely.
- Packing list detailing quantities, weights and packaging.
- Bill of lading (or other transport document) evidencing shipment; see our explainer on the bill of lading for importers.
- Certificate of origin, sometimes a preferential form to claim reduced duty, as covered in certificate of origin and preferential tariffs.
- Certificate of analysis (COA) or other quality evidence for the commodity.
- Insurance certificate, where the Incoterm (such as CIF) requires the seller to insure.
- Inspection certificate, phytosanitary certificate or fumigation certificate where the goods and destination require them.
Every document must be consistent with every other document and with the LC itself. A quantity on the packing list that does not reconcile with the invoice is a discrepancy, even if both are individually correct. These documents are issued by the supplier, independent labs and the relevant authorities, never by the buying agent.
Why do discrepancies cause delays, and how are they avoided?
Banks practise strict compliance: they check documents against the letter of the credit, not the spirit of the deal. Common discrepancies include a misspelled beneficiary name, an expired credit or shipment date, an inconsistent quantity, a missing endorsement, or a document described differently from the LC wording.
When a presentation is discrepant, the bank can refuse to pay or hold the documents until the buyer agrees to waive the issue. Either way, payment and the release of goods stall, sometimes for weeks, while corrections or waivers are arranged. The cure is preparation: agreeing realistic, achievable LC terms at the outset and checking the draft document set against those terms before presentation. Most discrepancies are avoidable with disciplined document control.
How does a buying agent support a letter of credit transaction?
A buying agent represents you, the buyer, and adds a layer of document discipline that prevents costly errors, but it stays firmly within its role. Karya Commodity does not issue, confirm or guarantee the credit; your bank and the participating banks carry the payment undertaking. What we do is help you set workable LC terms with the supplier, coordinate the documents the supplier and authorities must issue, and verify that the supplier’s presentation will match the LC before it goes to the bank, sharply reducing the risk of discrepancies.
This sits alongside the rest of our quality and compliance work: vetting the supplier, approving quality before shipment and monitoring the goods as the seller ships them through the relevant Indonesian port. Our role and our transparent commission stay separate from the banking. Remember that bank practice and trade rules evolve, so confirm current requirements and the applicable UCP rules with your bank or a trade finance specialist before opening a credit.
Set up a letter of credit that pays without delay
A well-structured LC protects both sides, but a poorly prepared one stalls on discrepancies and frustrates everyone. As your agent we will help you decide whether an LC fits your order, agree achievable terms with the supplier and verify the document set so the presentation is clean. Tell us about your order through our contact form and we will help you make the letter of credit work in your favour.