Confirmed Letter of Credit: How the Second Promise Works

A letter of credit replaces the buyer's promise with a bank's, which helps only if the exporter trusts that bank. An exporter selling into a market it knows little about may not know the issuing bank, may doubt its balance sheet, or may fear that a government short of foreign currency will stop payments abroad however willing the bank is. Confirmation meets both doubts by adding a bank the exporter does trust, and that bank carries the issuing bank's risk and the country's on its own books, against its own limits.

For the exporter's lender the change is as large. A receivable owed by an unfamiliar foreign bank is hard to lend against. One owed by a confirming bank, often the lender itself, is a claim on a known name, and can be discounted or counted as security in ways the unconfirmed credit cannot.

Documentary credits are commonly issued subject to the ICC's Uniform Customs and Practice for Documentary Credits, UCP 600, which govern a credit when its text says so. The rules treat confirmation as a firm promise by the second bank, on top of the issuing bank's, to pay or negotiate against a complying presentation, and they set out the sequence:

The confirming bank's obligation to the exporter stands on its own and does not wait on the issuing bank reimbursing it. A bank asked to confirm that is not prepared to must tell the issuing bank without delay, and may still advise the credit unconfirmed, which is how an exporter learns, before shipping, that the bank it hoped for will not stand behind the credit. The confirming bank charges a fee priced on the issuing bank, the country and the period at risk. The credit and the sale contract settle who pays it; it is often the exporter.

An exporter of food-processing machinery, constructed for this page, sells a line worth US$3.2m to a buyer in a country with a history of foreign-currency shortages. The buyer's bank issues a credit subject to UCP 600, payable 180 days after shipment, and asks the exporter's own bank to confirm. The confirming bank has room within its limits for the issuing bank and the country, and quotes 1.6% a year for the time it is at risk, here about nine months from confirmation to payment. The rate is the example's, not a market norm.

Five months after shipment, with the documents found complying and payment four weeks away, the buyer's country stops transfers abroad. The issuing bank is solvent but cannot send dollars. On the due date the confirming bank pays US$3.2m on its own undertaking and waits, as the issuing bank's creditor, for the controls to lift. The exporter's US$38,400 bought exactly that.

Now change one fact. Shipment slips four days past the latest date the credit allows, and the bill of lading shows it. The confirming bank finds the late shipment and refuses, by a single notice within five banking days. Its undertaking covers complying presentations only, so it owes nothing. The exporter is back on the buyer's willingness to waive the discrepancy and the issuing bank's ability to pay, the risks it had paid to escape. Confirmation removed the bank and country risk; it could not remove the documentary risk that the exporter's own staff controlled.

An advised credit has passed through a bank in the exporter's country that checked it was genuine and passed it on. The advising bank promises nothing, and a bank named in the credit to pay or negotiate has no duty to do so unless it has confirmed or expressly agreed. The exporter's risk is still the issuing bank's and the country's.

A silent confirmation is a promise a bank gives the exporter at the exporter's request, without the issuing bank's authority. Because the UCP describe a confirming bank as one acting on the issuing bank's request or authorisation, a silent confirmer is not a confirming bank under the rules. If the credit also nominates it and it pays or negotiates a complying presentation, it can claim reimbursement as a nominated bank; beyond that, its arrangement with the exporter is a private contract, and the exporter's protection is whatever that contract says.

Confirmation also differs from export credit agency cover and trade credit insurance, which pay a claim after a loss and subject to a policy's conditions. A confirming bank pays on the due date, against documents.

DEFINED IN ONE PARAGRAPH → · BANK GUARANTEE VS LETTER OF CREDIT → · USANCE CREDITS →

For the exporter's banker, confirmation turns a foreign bank receivable into a domestic one. A confirmed usance credit, once the documents have been found complying, can be discounted at a price set by the time left to maturity and the strength of the banks behind it, which is how the machinery exporter could have taken cash at shipment rather than at day 180. In a borrowing base, a lender may accept receivables under confirmed credits that it would exclude if the same amounts were owed by an overseas buyer on open account.

The decision that matters most comes earlier, in the sale contract. An exporter that agrees a credit to be confirmed by a bank acceptable to the seller, with the payer of the fee named, has settled the question before the buyer applies. One that agrees an unconfirmed credit and seeks confirmation later may find the issuing bank will not authorise it, or that its own bank has no limit left for the country.

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