A Guide to Letters of Credit & The Strategic Alternative: Trade Credit Insurance 

For centuries, the letter of credit (L/C) has been the gold standard for securing payments in international trade. It provides a robust guarantee, mitigating the risk of non-payment when dealing with unfamiliar buyers. However, in today’s fast-paced digital world, the cost, complexity, and inflexibility of L/Cs can be a significant business impediment. 

Many businesses are now discovering that trade credit insurance (TCI) offers a smarter, more modern alternative to secure transactions, protect against non-payment, and accelerate global growth. 

This guide explores how letters of credit work, their inherent drawbacks, and why TCI has become the strategic choice for thousands of exporters worldwide. 

A letter of credit is a formal undertaking by a buyer's bank to pay a seller a specific sum of money, provided the seller submits documents that are in perfect compliance with the L/C's terms and conditions. In essence, it substitutes the bank's creditworthiness for the buyer's, giving the seller a high degree of payment security. 

How a Letter of Credit Works: A Step-by-Step Process 

1. Agreement: The buyer and seller agree to use an L/C in their sales contract. 
2. Application: The buyer (applicant) applies for an L/C from their bank (the issuing bank). 
3. Issuance: The issuing bank sends the L/C to the seller's bank (the advising bank). 
4. Shipment: The seller (beneficiary) reviews the L/C and, if acceptable, ships the goods. 
5. Documentation: The seller gathers all required documents (e.g., bill of lading, commercial invoice) and presents them to their bank. 
6. Payment: If the documents are fully compliant, the bank pays the seller. 

Common Types of Letters of Credit 

• Irrevocable L/C: The standard today. It cannot be amended or cancelled without the consent of all parties. 
• Confirmed L/C: A second bank (the confirming bank, usually in the seller's country) adds its own guarantee of payment. This protects the seller if the issuing bank or its country faces political or economic risk. It is highly secure but very expensive. 
• Sight L/C vs. Usance L/C: A sight L/C is paid immediately upon presentation of compliant documents. A usance L/C is paid at a future specified date (e.g., 90 days after shipment). 
• Standby L/C (SBLC): Acts as a financial backup. It is not the primary payment method but is drawn upon only if the buyer fails to pay. 

While secure, L/Cs present significant disadvantages for both buyers and sellers. 

For the Buyer: 

• 🔴 High Cost: L/Cs can cost 1-3% of the transaction value, a direct cost that makes goods more expensive. 
• 🔴 Ties Up Working Capital: The L/C utilizes the buyer's bank credit line, restricting their financial flexibility for other needs. 
• 🔴 Complex & Slow Process: The application and approval process involves extensive paperwork and can cause significant delays. 

For the Seller: 

• 🔴 Strict Documentary Compliance: The core risk shifts from non-payment to documentary risk. Even a minor typo or discrepancy in the documents can lead to the bank refusing payment, defeating the purpose of the L/C. 
• 🔴 Slows Down Business: The time required to issue, check, and process L/C documents can delay shipments and slow down the entire sales cycle. 
• 🔴 Strains Customer Relationships: Forcing a buyer to go through the costly and cumbersome L/C process can be a point of friction, especially when competitors are offering more flexible terms. 

Trade credit insurance (TCI) offers the same core benefit as a letter of credit—protection against non-payment—but without the high costs, administrative burdens, or negative impact on your customer relationship. 

Key Benefits of Trade Credit Insurance: 

• ✅ Protection Against Non-Payment: TCI ensures you get paid if a buyer defaults due to insolvency, protracted default, or political risks. 
• ✅ Increases Sales with Open Account Terms: TCI gives you the confidence to offer competitive open account (e.g., Net 30/60/90) payment terms. According to the WTO, foreign buyers purchase significantly more when offered open terms. 
• ✅ Doesn’t Tie Up Your Buyer’s Credit: TCI is a policy taken out by you, the seller. It has no impact on your buyer's credit lines, making you a more attractive business partner. 
• ✅ Covers Multiple Transactions: Unlike most L/Cs which are per-transaction, a TCI policy provides ongoing protection for all your sales to insured buyers. 
• ✅ Lower Cost & Simpler Process: TCI is generally cheaper than L/C fees and is seamlessly integrated into your business operations. 

📌 Example: A European electronics supplier used trade credit insurance to offer longer payment terms to international buyers, resulting in a 20% increase in global sales and stronger customer loyalty. 

While letters of credit still have a place in specific high-risk scenarios, they are often an outdated and inefficient tool for modern global trade. They increase costs, slow down deals, and create friction with your customers. 

Trade credit insurance offers a more affordable, efficient, and scalable solution. It empowers you to: 

• Reduce transaction costs. 
• Strengthen customer relationships by offering competitive open terms. 
• Expand sales opportunities safely, both at home and abroad. 

📌 Allianz Trade offers industry-leading trade credit insurance solutions that help businesses reduce risk, increase sales, and streamline global trade. 

Ready to move beyond the limitations of L/Cs? Contact an Allianz Trade expert to learn more.