An exporter in Vietnam ships furniture to a buyer in France. Neither party fully trusts the other. The buyer does not want to pay before receiving the goods. The seller does not want to ship before being paid. A letter of credit solves the problem. The buyer's bank promises to pay the seller once the seller presents documents proving the goods were shipped as agreed.

The mechanics are precise. The buyer and seller agree on terms. The buyer's bank issues the letter of credit, which specifies the documents required: a bill of lading, an invoice, a packing list, an insurance certificate. The seller ships the goods and presents the documents to its own bank, which forwards them to the buyer's bank. If the documents comply exactly, the bank pays. If they do not, the bank can refuse. Banks deal in documents, not goods.

Letters of credit are common in international trade because they reduce risk for both sides. They are also used in domestic transactions and construction projects. The cost is a fee, usually a percentage of the credit amount. The process is slow and document-heavy, which is why some trade has shifted to open account terms backed by credit insurance.

The key principle is strict compliance. A misspelled name or a missing signature can void the letter. That rigidity protects the bank, but it can frustrate traders.