Dual Circulation and RMB Internationalisation: One Letter of Credit at a Time

Although this instrument has technically existed for a couple of decades, it truly gained traction after 2016, thanks in large part to newer rules embodied in the 2016 version of the Domestic Letter of Credit Settlement Management Measures (国内信用证结算管理办法).

First, there was economic slowdown. China’s GDP growth had dipped below 7%, and bad loans were piling up. Regulators needed safer ways to facilitate trade. Second was the shadow banking crackdown. High-risk informal lending was under scrutiny. Domestic LCs offered a regulated alternative. Third was the tech boom: e-commerce and digital finance were exploding. The Domestic LC system needed to catch up with digitalised trade and meet the needs of the SMEs. Now, in 2025, the annual transactional value of Domestic LCs has reached over RMB4 trillion.

First of all, UCP600 is not a law but an internationally recognised set of rules. Banks and traders may or may not choose to incorporate UCP600 into their Letters of Credit. It applies across jurisdictions if the credit says so. In contrast, China’s 2016 regime is a set of rules or guidelines specifically issued within China. They are used for RMB credits involving domestic parties.

Secondly, Domestic LCs may be used for service payments, while International LCs under UCP600 are only used for payments for goods.

Thirdly, while the Chinese rule largely follows the conceptual system adopted by UCP600, certain differences emerge in the wake of the domestic market practice and institutional background. For example, most experts and practitioners think that under UCP600 issuing banks cannot be negotiating banks. But in China, such is not only common but a majority of the transactions, so much so that maybe one has to emphasise that when issuing banks purchase from beneficiaries against the documents presented, such purchase is no longer negotiating in the classic sense. Call it financing, discounting or forfaiting. But we do not need to get into the fine scholarship on this issue here.

Suffice it to say, forfaiting has become a popular way of dealing Domestic LCs in China. While China’s Domestic LCs were originally meant to lubricate the domestic trade of goods and services, over a decade they became a class of financial assets frequently traded among domestic banks by way of secondary market forfaiting transactions.

Here is where it gets spicy. In the same decade that Domestic LCs and domestic forfaiting grew substantially, cross-border RMB transactions also took off. So, too, did the overseas branches of Chinese banks. Letters of Credit and forfaiting are all about trust. Chinese Domestic LCs are hardly known outside of Mainland China, let alone trusted by international financial institutions. But it is good enough that Chinese banks’ overseas branches have both familiarity and trust in Chinese Domestic LCs.

Hong goes on to talk about related aspects, such as interest rates. He also notes the consideration of how the RMB is used “here and there” to facilitate the trade of goods in China, as well as mentioning the ongoing US–China trade war.

The ten-year evolution testifies to China’s financial strategy: controlled innovation, state-guided globalisation, and the quiet rise of the RMB.

It goes without saying that the evolution continues. Three trends to watch are as follows.