Understanding Letters of Credit in Apparel Trade

Global apparel trade runs on tight margins, tight schedules and tight trust. When a factory in Tiruppur ships a container of shirts to a buyer in Europe, both sides want certainty. The buyer wants assurance that the goods meet the agreed specifications. The seller wants assurance that payment will arrive. A letter of credit is the instrument that often bridges this gap, converting commercial trust into a bank promise and allowing both parties to get on with business.

What is a letter of credit?

A letter of credit is a commitment by a bank, made at the request of an importer, to pay an exporter a specified sum provided the exporter presents the documents required under the credit. In effect, the exporter is paid by the bank rather than relying solely on the buyer. Letters of credit are also called documentary credits, and they are used widely where trading partners operate under different legal systems, where one party is new to the other, or where significant value and delivery risk exist.

The core parties and their roles

A typical letter of credit transaction involves four main actors. The buyer or applicant asks their bank to open the credit. The issuing bank issues the LC and undertakes to make payment when the conditions are met. The beneficiary is the exporter who ships the goods and then presents documents to claim payment. The advising or confirming bank, usually the exporter’s bank, checks documents, may add its confirmation, and can pay the exporter on behalf of the issuing bank. Banks act on documents, not on the physical goods, so precise paperwork is everything.

How a letter of credit works step by step

Letters of credit follow a standard sequence, which helps make transactions predictable.

1. The buyer and seller sign a sales contract that specifies payment by letter of credit and lists the documents required.
2. The buyer applies to its bank to issue an LC in favour of the seller for the agreed amount.
3. The issuing bank sends the LC to the advising bank, which notifies the exporter. If requested, the advising bank can add its confirmation.
4. The exporter ships the goods and collects the commercial documents required under the LC, for example, the bill of lading, commercial invoice, packing list and any certificates requested.
5. The exporter presents the documents to the advising bank for examination. If the documents comply with the LC terms, the advising or confirming bank pays or accepts a draft.
6. The advising bank forwards documents to the issuing bank, which, on checking and finding a complying presentation, pays the advising bank and debits the buyer’s account or arranges reimbursement.
7. The buyer receives the documents and uses them to clear the goods at the destination. Each step is governed by the credit and the international rules specified by the parties.

Key rules and standards

To reduce disputes over documentary interpretation, banks around the world usually apply the Uniform Customs and Practice for Documentary Credits, commonly known as UCP 600. Published by the International Chamber of Commerce, UCP 600 sets out standard definitions and practices so that banks in different countries interpret documentary credits in the same way. Parties may also use the eUCP for electronic presentations and other supplementary rules depending on their needs. Using these agreed frameworks makes credits more predictable and reduces the chance of costly disagreements.

Why letters of credit matter for the apparel sector

The apparel trade has seasonality, strict quality expectations and complex supply chains. Retail buyers demand punctual delivery and compliance with fabric and workmanship specifications. Exporters need reliable payment to manage cash flows for yarn, labour and finishing.

Letters of credit reduce both commercial and country risk by substituting the credit of the issuing bank for the buyer’s commitment. For Indian apparel exporters, especially those dealing with larger chains or new buyers, LCs can be the difference between winning an order and losing it. They also provide export finance opportunities because banks can discount documents or provide pre-shipment finance backed by a confirmed credit.

Advantages and trade-offs

Letters of credit bring clear benefits. Exporters gain payment assurance provided they meet document requirements. Importers can require documentary proof of shipment and compliance before payment is made. Banks provide an intermediary role that reduces counterparty risk and supports financing. However, there are costs and constraints. LCs involve bank fees and can be paperwork-heavy.

Banks examine documents with strict compliance in mind, so even minor discrepancies can delay or block payment. For textile exporters, this makes careful packing lists, correct invoice details and precise bill of lading descriptions critical. The decision to use an LC, therefore, balances the cost and administrative burden against risk mitigation and market access.

Practical tips for apparel exporters

Success with letters of credit requires process discipline and clear communication.

• Read the LC carefully as soon as it arrives and compare each clause with the sales contract.
• Clarify ambiguous terms with the buyer and, if needed, seek an amendment to the LC before shipping.
• Prepare documents exactly as required. Use professional document checklists and have a second person verify the details.
• Consider asking for a confirmed LC if you are concerned about the issuing bank or country risk. A confirmed LC gives you a second bank’s undertaking and may facilitate financing.
• Work with a bank that understands textile trade documents. Experienced trade officers can flag likely discrepancies before documents are presented.

Alternatives and when to use them

Letters of credit are not the only payment method. Open account terms, documentary collections and advance payments each have their place. Opening an account is common when there is high trust and strong buyer relationships because it offers the lowest cost to the buyer.

Documentary collections are cheaper than LCs but do not carry the same payment guarantee since banks do not assume payment risk. Choosing the right instrument depends on the buyer relationship, the political and commercial risk profile, and cost considerations. For new buyers or high-value shipments, letters of credit remain a trusted solution for many apparel exporters.

A final stitch

Letters of credit are a practical expression of how finance and logistics meet in the apparel trade. They do not remove quality risk or replace sound contracting, but they provide a bank-backed payment promise that unlocks business across borders.

For Indian manufacturers and exporters, understanding how credits work, investing in document accuracy and developing a relationship with trade-savvy banks turns this instrument from a bureaucratic hurdle into a strategic advantage. In an industry where timing, trust and cash flow matter equally, letters of credit remain one of the most important tools in the exporter’s toolkit.