Letter of Credit — A UAE SME Guide

What a Letter of Credit is

A Letter of Credit (LC) is a payment guarantee issued by a bank on behalf of a buyer (the importer) to a seller (the exporter). It promises that the bank will pay the seller a specified amount once the seller presents documents that prove the agreed goods have been shipped in accordance with the LC terms.

The LC shifts payment risk from the seller to the buyer's bank. The seller no longer needs to trust the buyer's willingness or ability to pay — they are relying on the creditworthiness of the buyer's bank, which is a much stronger counterparty.

Why it happens

The UAE is one of the world's largest trade hubs, with significant import and re-export activity across commodities, manufactured goods, and industrial products. LC usage is standard in several trade relationships — particularly cross-border trade with suppliers in Asia, Europe, and the Americas who are unwilling to ship on open account terms to a buyer they do not know well.

For UAE importers, the LC also provides a financing mechanism: the bank funds the payment to the overseas supplier, and the importer repays the bank over an agreed period — often linked to a Trust Receipt arrangement.

What to check

Irrevocable LC: cannot be cancelled or amended without the consent of all parties. This is the standard form — it provides the seller with a firm payment commitment.

Sight LC: payment is made immediately upon presentation of conforming documents. No credit period.

Usance (deferred payment) LC: payment is made after a specified period — 30, 60, or 90 days after the bill of lading date. Provides the importer with a credit period before payment is due.

Confirmed LC: a second bank (usually the seller's bank) adds its own payment guarantee, providing additional security where the buyer's bank is less well-known or in a higher-risk jurisdiction.

What to do

When buying from a new international supplier who does not yet offer open account terms — the LC gives the supplier sufficient comfort to ship without prior relationship.

When the transaction value is large enough that non-payment risk to the seller is significant — LC protection is more justified for a USD 500,000 shipment than a USD 5,000 one.

When the buyer needs a financing period — a usance LC combined with a Trust Receipt gives the importer time to receive, clear, and sell goods before the payment falls due.

When the supplier requires it as a condition of the contract — in this case there is no decision to make.

What to check

LCs carry banking fees: issuance fees (typically 0.15 to 0.5% of the LC value), amendment fees, and utilisation charges. For large LCs on extended terms, these costs are material. The all-in cost should be compared to alternative financing arrangements before choosing this structure.

An LC is a precision instrument — it works well when the documentation is correct and the parties understand their obligations. When documents do not comply with LC terms, payment can be refused by the issuing bank even if goods have been delivered correctly. Document discipline — ensuring every field in every shipping document matches the LC exactly — is as important as the financial mechanics.

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