Letter of Credit (LC) Discounting: Process, Interest Rates & Example

A Letter of Credit (LC) is a capital instrument that helps businesses get money quickly without a loan. It is for those who deal in international trade—like exporters, traders, or small business owners—who need faster access to funds. This blog explains how LC discounting works, the process, the charges involved, interest rates, required documents, and a simple example to make it easy to understand.

What is Letter of Credit (LC) Discounting?

Letter of Credit (LC) discounting is a capital instrument used in international trade. When a buyer agrees to pay for goods through a letter of credit, the exporter can approach a bank to get the payment before the actual due date. The bank checks the letter and pays the exporter after keeping a small charge. Later, the bank collects the full amount from the buyer's bank.

Who Should Use LC Discounting?

LC discounting is best suited for businesses with long payment cycles but need steady cash flow to operate smoothly. This includes:

• Exporters in high-volume, low-margin industries like garments, agriculture, or electronics, where delayed payments can disrupt the supply chain.
• SMEs dealing with large international buyers who insist on credit terms via LC, leaving smaller suppliers cash-strapped.

LC Discounting Process

This process usually involves three parties: the exporter, the exporter's bank, and the buyer's (issuing) bank. It occurs after the exporter has shipped the goods and wants to receive payment before the buyer's due date.

Exporter gets LC from buyer's bank → Ships goods → Submits documents to their bank → Documents sent to issuing bank → If terms are met, issuing bank accepts → Exporter's bank offers discounting → On approval, charges are deducted and funds are released.

Types of LC Bill Discounting

LC-backed bill discounting happens in two main ways: from the seller's or buyer's side. Both help businesses get or manage money faster using the letter of credit.

Sales Side LC Discounting: Sellers use LC discounting to get quick cash instead of waiting for the buyer's payment. For example, if payment is due in 60 days, the seller submits the LC and shipment docs to the bank and gets most of the money instantly, minus a small fee. The buyer's bank pays the full amount later.

Purchase Side LC Discounting: Buyers use it to delay the outflow of money and still keep the supplier happy. For example, imagine you're a buyer and don't want to pay the seller upfront. You ask your bank to pay the seller early using the LC. Your bank pays them (after a discount), and you settle with your bank later.

Inland LC Discounting (Within the same country): This works just like the above, but for local trade. A Delhi wholesaler buying from a Gujarat factory can also use LC discounting if both use Indian banks. The idea is the same—the seller gets paid early, and the buyer gets to pay later.

Letter of Credit Discounting Charges & Interest Rates

Documents Required for LC Discounting

Before the bank can give you money under LC discounting, it must check that everything is in order. These documents prove that goods have been sent, the buyer has agreed to pay, and all terms of the letter of credit are followed.

Here's what you need to submit:

• Letter of Credit (LC) – A copy of the LC issued by the buyer's bank.
• Bill of Exchange – A written request from the seller asking the bank to collect payment.
• Commercial Invoice – A bill showing the value and details of the goods sold.
• Packing List – A simple list of everything that's packed and shipped.
• Transport Documents—Depending on how the goods were sent, these may include a bill of lading, airway bill, or lorry receipt.
• Shipping Bill or Delivery Proof – Shows that the goods have been sent.
• Insurance Certificate – Confirms that the goods are covered during transport.
• Discounting Request Letter – A letter from the exporter asking the bank to give the payment early.
• Certificate of Origin – Sometimes needed to show where the goods were made.
• Inspection Certificate—This is needed only if the LC asks for it to confirm that the goods meet quality standards.

Example of LC Discounting

Here's an LC discounting example: A textile exporter in Surat ships ₹50 lakh of fabric to a US buyer under a 60-day LC. After submitting the shipment documents, the exporter will request an LC discount. The bank deducts ₹1.5 lakh as charges and credits ₹48.5 lakh instantly. On day 60, the buyer's bank pays the full amount, completing the transaction.

LC Discounting Letter Format

An LC discounting letter is written by the seller (exporter) to the bank, asking for early payment against a letter of credit. The letter must be formal and include all required transaction details.

Main Parts of the letter:

• Date
• Recipient (To)
• Sender Information (From, Address, City, Country, Contact Details)
• Reference Details
  1. Pro-Forma Invoice No.
  2. Purchase Order No.
  3. Commercial Contract No.
• Terms & Conditions
  1. LC issuance deadline and acceptable bank
  2. LC must be irrevocable and comply with UCP 600
  3. LC must allow negotiation by any bank
  4. Full SWIFT details for LC opening
     • In favor of
     • Attn
     • Telephone
     • Company name and address for mailing
  5. LC amount (up to or approximate)

Benefits of LC Discounting

In international and domestic trade, payments under a Letter of Credit (LC) are often delayed by 30, 60, or even 90 days. LC discounting allows sellers to receive funds earlier by using the LC as a secure payment instrument. This provides several practical benefits for businesses.

1. Faster Cash Flow: The seller gets access to funds immediately after shipment instead of waiting for the LC payment date.

2. Improved Working Capital: Early payment helps manage day-to-day operations like buying raw materials, paying salaries, or accepting new orders.

3. Lower Dependency on Loans: Instead of taking a business loan, the seller can meet financial needs through LC discounting, which is often cheaper.

4. Reduced Payment Risk: Since the bank checks documents before discounting, and the buyer's bank backs the payment, the risk of non-payment is lower.

5. Better Business Planning: Predictable cash inflow allows sellers to plan production, inventory, and new deals more confidently.

Export Bill Discounting Under LC

Export bill discounting under letter of credit (LC) is a way for exporters to receive payment earlier by using the LC as a guarantee. The process works like this:

1. The exporter ships goods and sends export documents (like invoices, bills of lading, and insurance) to their bank.
2. The bank confirms everything matches the LC and accepts the bill.
3. Using the LC as security, the bank advances most of the payment (after deducting fees).
4. On the agreed date, the exporter's bank collects the full payment from the buyer's bank. 

LC Discounting vs Invoice Discounting