So far, I have defined what letter of credit is and explained its types, parties involved in and their roles and responsibilities, transaction steps and risks associated with different involving parties.
Additionally, you can find detailed information regarding issuing bank, confirming bank, nominated bank and advising bank on my previous posts.
Today, I explain the concept of confirmation as well as its main advantages to exporters.
What is Confirmation?
Confirmation means a definite undertaking of the confirming bank, in addition to that of the issuing bank, to honour or negotiate a complying presentation.
The main difference between a confirmed letter of credit and an unconfirmed letter of credit is the institution that gives payment undertaking.
Under an unconfirmed letter of credit, only the issuing bank gives the conditional payment undertaking.
Under a confirmed letter of credit, on the other hand, both the issuing bank and the confirming bank give separate conditional payment undertakings to the beneficiary.
Below illustrations explain the difference with an example more clearly.
Unconfirmed Letter of Credit Example:
An edible oil importer in Iraq signs a proforma invoice with an exporter in United States to supply of 3000 m tons corn oil packed in different types plastic jars.
The payment method is at sight letter of credit.
Issuing bank is not granted any confirmation authorization to the advising bank.
Because the advising bank did not add its confirmation to the letter of credit, it has no payment obligation against the beneficiary.
The exporter will get the payment from the issuing bank, after the issuing bank determines the complying presentation.
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| Unconfirmed letter of credit: Issuing bank's payment undertaking |
Confirmed Letter of Credit Example:
In order to adapt above example to a confirmed letter of credit scenario, we need to add a confirming bank to the equation.
This time, when transmitting the credit to the advising bank, the issuing bank is requesting from the advising bank to confirm the credit.
The advising bank, which most probably also the nominated bank, may or may not add its confirmation to the credit.
If the advising bank elects to add its confirmation, the credit becomes confirmed letter of credit, and the advising bank becomes both advising bank and confirming bank. (probably also the nominated bank.)
The confirming bank is irrevocably bound to honour or negotiate as of the time it adds its confirmation to the credit.
As I have explained before, confirmation means a definite undertaking of the confirming bank, in addition to that of the issuing bank, to honour or negotiate a complying presentation.
Under a confirmed letter of credit, according to letter of credit rules, the exporter should present the documents to the confirming bank and gets the payment if the confirming bank finds presentation is complying.
Then the confirming bank should seek reimbursement from the issuing bank through a reimbursing bank.
What are the Advantages of a Confirmed Letter of Credit?
By having a letter of credit confirmed, the exporter;
- can eliminate country risk of the issuing bank.
- can eliminate bankruptcy risk of the issuing bank
- can eliminate uncertainty related risks of the issuing bank such as non-professional act when checking the documents. Please kindly keep in mind that banks in various countries do not act according to letter of credit rules. (UCP 600 and ISBP 745)
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