Step 1.

The buyer agrees to purchase goods from the seller using a letter of credit as the mechanism of payment.

Step 2.

The buyer applies to his bank for a letter of credit, signing the bank’s letter of credit application/agreement form.

Step 3a.

After approving the application, the issuing bank issues the actual letter of credit instrument and forwards it to their chosen advising bank.

Step 3b.

At the time the L/C is sent, the issuing bank may also send a reimbursement authorization to their chosen reimbursing bank.  This bank is the clearing bank the issuing bank uses when making payments in the currency of the L/C and will play a role when the time comes to pay the L/C.

Step 4.

The advising bank authenticates the letter of credit and delivers it to the beneficiary (the seller).  If the issuing bank has requested them to do so, the advising bank may add their confirmation to the L/C (and thereby become the confirming bank).

Step 5.

Having received the issuing bank’s assurance of payment (and that of the confirming bank if the L/C has been confirmed), the seller delivers goods to a freight forwarder, who ships the merchandise to the buyer.

Step 6.

The seller, the freight forwarder, and/or a document preparation company prepares the documents called for in the letter of credit and presents them to the “nominated bank.”  The letter of credit may nominate a specific bank where documents are to be presented or it may say it is “available with any bank,” giving the seller the freedom to choose where to present documents.  If the L/C has been confirmed, documents must be presented to the advising/confirming bank.

Step 7.

The nominated bank examines the documents and, if they comply, obtains funds for payment to the beneficiary in accordance with the terms of the letter of credit, generally by sending a reimbursement claim to the reimbursing bank.

Step 8.

The reimbursing bank matches the negotiating bank’s claim against the reimbursement authorizations they are holding, charges the issuing bank’s account, and transfers funds to the nominated bank.

Step 9a & b.

The nominated bank transfers payment to the beneficiary (seller) and forwards the documents to the issuing bank.

Step 10a & b.

The issuing bank examines the documents.  If it agrees with the nominated bank that the documents comply with the letter of credit, the issuing bank obtains payment from the applicant (buyer) in accordance with the terms of the applicant’s letter of credit agreement and forwards the documents to the applicant.

Step 11.

The applicant (buyer) uses the documents to pick up the merchandise from the carrier, completing the letter of credit cycle.