International trade is an essential part of many businesses, offering growth opportunities to expand and scale. However, it also comes with risks such as commercial defaults and documentation errors. To safeguard business owners from such challenges, financial instruments like the confirmed letter of credit are used under business banking services.
In this article, we will cover what is a confirmed letter of credit and its importance.
H2: What is a Letter of Credit?
A letter of credit (LC) is a secure payment mechanism for international trade. It is a financial document which is issued by a bank or financial institution that guarantees a bank’s payment to a seller. The letter of credit generally involves the applicant (buyer/ importer), beneficiary (seller/exporter), issuing and advising bank. In some cases, a second confirming bank is involved as guarantee to the LC, providing an extra layer of payment security.
- H3: Role in International Trade
In foreign trade, a Letter of Credit (LC) is an important financial protection that builds trust and reduces risks among a buyer and a seller, particularly when they are from different nations and hence unfamiliar with each other. It in effect transfers the risk of payment from a buyer to a reliable, third-party bank.
- H3: Types of Letters of Credit
Letters of credit (LCs) are financial instruments used in international trade to guarantee payment from a buyer to a seller. They differ in terms of revocability, confirmation, payment timing, and structure.
- H4: Based on revocability: Revocable, Irrevocable
- H4: Based on confirmation: Confirmed, Uncofirmed
- H4: Based on payment timing: Sight, Usance (Deferred)
- H4: Based on structure and purpose: Transferable, Back-to-back LC, Standby LC (SBLC), Revolving, Red Clause, and Green Clause.
H2: Confirmed Letter of Credit
A letter of credit (LC) is a financial instrument used in international trade to provide payment security for both the exporter and the importer. What distinguishes a confirmed LC from other types is the involvement of two banks, the issuing bank and the confirming bank. The confirming bank, usually located in the exporter’s country, adds its own guarantee to the LC issued by the importer’s bank, offering the exporter an additional layer of assurance.
H2: Example of a Confirmed Letter of Credit
An Indian exporter sells pharmaceuticals to a buyer in Germany for USD 100,000. The buyer requests its local bank to issue a letter of credit in favour of the exporter. To minimise the risk of non-payment due to distance or unfamiliar banking regulations, the exporter asks for the LC to be confirmed by a reputed Indian bank.
After the confirming bank in India adds its guarantee, the exporter ships the goods and submits the required documents such as the bill of lading and commercial invoice to the confirming bank. Once the documents are verified and found to meet the LC terms, the confirming bank pays the exporter. It then recovers the payment from the issuing bank in Germany.
This arrangement protects the exporter against both the buyer’s default and any payment risk arising from the issuing bank or its country. For growing enterprises using digital business loans to fund exports, confirmed LCs offer additional payment security and cash flow predictability.
H2: Confirmed vs. Unconfirmed Letter of Credit
Now that we have covered what is a confirmed letter of credit, it is important to be aware of the differences between confirmed and unconfirmed letter of credit.
- Payment Assurance: Both the issuing bank and the confirming bank give their undertaking and confirmation in a confirmed letter of credit regarding the on-time payment to the seller for their delivered goods and services while there is only an issuing bank is a guarantor in case of unconfirmed letter of credit.
- Costs: An unconfirmed letter of credit is less expensive, as no confirming bank charges apply. A confirmed LC, however, incurs additional costs due to the confirming bank’s involvement. Businesses using a digital business loan to finance exports may prefer confirmed LCs for the added security despite higher costs.
- Customisation: Only the buyer or importer is permitted to review the letter of credit and, if required, make some modifications in unconfirmed LCs. If there are any corrections, the beneficiary can contact the applicant rather than the issuing bank. In the case of confirmed LCs, the confirming bank has the ability to verify the Letter of Credit in addition to the beneficiary and make any necessary modifications directly from the issuing bank.
- Flexibility: While confirmed letters of credit take longer to process, unconfirmed letters are simpler and require less time.
H2: Advantages of Confirmed LC
A confirmed letter of credit offers several benefits for exporters:
- Enhanced payment security: The confirming bank guarantees payment in addition to the issuing bank, protecting the exporter against default or political risk.
- Trust and credibility: It builds confidence between trading partners, especially when dealing with new buyers or unfamiliar markets.
- Reduced country and bank risk: The exporter is safeguarded from issues arising from the issuing bank’s financial instability or the buyer’s country conditions.
- Timely payment: Once all LC terms are met and documents are verified, the confirming bank ensures prompt release of funds.
- Support for high-value transactions: Ideal for large or complex trade deals where an additional layer of assurance is required.
H2: Conclusion
A confirmed letter of credit helps build trust and ensure payment security in international trade. With both issuing and confirming banks involved, it protects exporters from commercial and political risks while assuring importers of payment on compliance. For growing businesses, combining confirmed LCs with digital business loans and strong business banking support can enhance trade confidence and financial stability.
Confirmed Letter of Credit: Definition, Example, vs. Unconfirmed
