A confirmed Letter of Credit is an LC guaranteed by two banks. However, the confirming bank does not just agree to honour the Letter of Credit but also take responsibility for payment in case both buyer and primary issuing bank default.
A confirmed LC requires confirmation by the buyer’s bank or any other bank deemed reliable by the seller. In this case, the bank charged with the task of confirming the LC shall be liable for the performance of obligations.
For instance, if Bank B confirms an LC issued by bank A, the former is expected to ensure payment as at when due. It comes at a price anyway.
Why the Need for Confirmation?
Do you know that it’s not all banks that can pay should their customer default? It’s one thing for a bank to issue a Letter of Credit, but it’s another thing for them to have the capacity to pay you. Ultimately, verifying the issuing bank’s financial strength is a good idea to be on a safe side.
Also, sellers often request confirmation from another bank aside from the issuing bank if they have little or no confidence in the latter’s ability to pay. The decision to demand further approval is to guard against payment delay/default by banks with insufficient funds.
Advantages of A Confirmed Letter of Credit
A few advantages of a confirmed Letter of Credit include guaranteed payment, minimized credit risk, and easy solvency check. Let me explain further for more clarity.
A Confirmed Letter of Credit is more secured because the confirming bank does guarantee payment to the seller after order fulfilment. When a more creditworthy bank confirms an LC, you are sure of getting paid on time.
Also, it helps the seller to reduce credit risk. In other words, you are not going to get stuck to a deal that will end up in a mess. Moreover, delayed payment may result in huge losses.
Furthermore, with a Letter of Credit, it is easy to ascertain the creditworthiness of a prospect without having to travel to his country. Also, it takes away the troubles connected with the physical check on a prospective buyer.
Disadvantages of Confirmed LC
As good as confirmed letter of credit is, there are few hiccups you have to consider before opting for it. Here are a few of them.
First, a confirmed LC increases business cost. The reason being that the two involving banks will charge you their fees for the issued LCs. However, you can avoid this additional cost by making sure the primary issuer is a reputable bank.
Second, transaction hitches may occur if the seller’s bank refuses to confirm the original LC. Your bank may decline the first Letter of Credit’s confirmation if they are not satisfied with issuing bank’s credit standing. If a seller’s bank decline confirmation, getting another bank to do that may take a while.
Third, you may get discouraged if your bank fails to confirm the first LC. Ultimately, your bank’s rejection serves as a red flag, and you may begin to lose interest in a good deal.
Fourth, you may end up with another bank with slim capacity to perform agreeing to confirm the first LC.
In conclusion, Letters of Credit are generally good. However, if you are not satisfied with an issuing bank, do opt for Confirmed LC. Don’t forget to read our previous article on other types of LC.