A letter of credit lets a buyer and seller who do not know each other complete a shipment. The mechanism works because the bank's promise is tied to paperwork, not to cargo.
The promise being made
The issuing bank undertakes to pay the seller if the seller presents documents that comply with the credit's stated terms within the stated period.
That undertaking is independent of the sales contract. Even if buyer and seller are in dispute, the bank must pay on a complying presentation.
This independence is the point. The seller is relying on a bank's credit rather than on a distant buyer's willingness to pay after receiving goods.
Why documents rather than goods
Banks cannot inspect cargo in a foreign port, and they do not want to become arbiters of quality disputes. Documents are something a bank can examine.
The typical set includes a transport document, a commercial invoice, an insurance document, and certificates covering origin, inspection or packing as the credit requires.
Examination is limited to whether documents appear on their face to comply. A bank checking a certificate is confirming it exists and matches, not verifying its underlying claim.
What strict compliance means in practice
Discrepancies are common, and many are trivial: a misspelled name, a date outside the shipment window, a document missing a required signature.
A discrepant presentation releases the bank from its obligation. The buyer may still waive the discrepancy and authorize payment, which frequently happens, but the seller no longer has the guarantee.
Sellers therefore prepare documents against the credit's exact wording, and often ask for amendments before shipping rather than argue afterward.
How confirmation adds a second promise
A seller may not want to rely on a bank in the buyer's country, particularly where transfer of funds could be restricted. Confirmation addresses this.
A confirming bank, usually in the seller's country, adds its own undertaking to pay against complying documents. The seller then looks to a bank it can reach.
Confirmation is priced according to the perceived risk of the issuing bank and its jurisdiction, which is why the cost varies widely between corridors.
Why usage has changed over time
Letters of credit are expensive and document-heavy, so established trading relationships often move to open account terms, where the seller ships and invoices directly.
The instrument remains common in new relationships, in higher-risk corridors, and where financing depends on the bank's undertaking as security.
Its persistence reflects the fact that no cheaper mechanism has replicated an independent bank promise that a seller in another country can enforce.