Difference Between Confirmed And Unconfirmed Letter of Credit
If you are running an international business, you may be aware of what a letter of credit is. It is a legal document that is issued by a bank or a private financial institution to the exporter on behalf of the importer guaranteeing that the amount of LC agreement will be paid on-time. And if the importer is unable to do so, it will be covered by the issuing bank. In short, here the bank acts as a financial guarantor for the importer and ensures the exporters the amount for their delivered goods and services. But when it comes to the types of letters of credit, you often get confused between confirmed and unconfirmed LC.
In this blog, you will get to know what is confirmed LC and how confirm letters of credit are different from unconfirmed LC. Keep reading to know:
What Is A Confirmed Letter Of Credit?
A confirmed LC is a Bank Credit Letter where the payment guarantee of the seller or exporter is backed up by a second bank or a confirming bank. In simple words, in case if the first bank defaults to pay, or a seller isn't satisfied with the creditworthiness of the first bank, he may require a confirmed irrevocable letter of credit, so that the payment will be covered by the second bank. This type of trade finance service payment method contains an LC confirmation and is used by importers and exporters in international trade where an additional guarantee is provided to the original LC from a second bank. The borrowers are required to apply for the confirmed LC if the seller is not convinced about the assured payment.
If there is a confirmed LC at sight that has been issued in favor of the exporter, then the exporter will be paid at sight to the exporter. To simplify confirmed lc meaning, a confirm LC is a letter of credit where the seller has a payment guarantee from a second bank or a confirming bank.
How Confirmed Letters of Credit Work
Letters of credit are most frequently used in international trade and business transactions involving sizable payments for goods or services. Instead of requesting an advance payment, the vendor may insist that the buyer get a letter of credit for the balance owing upon delivery. This letter serves as a guarantee that the buyer's bank will make a prompt and complete payment. The bank will be responsible for covering any outstanding debt if the buyer doesn't fulfill their contractual commitment. Letters of credit are often only valid for a predetermined period of time, usually 90 days.
A confirmed letter of credit gives the seller or exporter a payment assurance from a second bank, often known as a confirming bank. If the first bank is unable to pay, the second bank is expected to complete the payment. This is an international trade payment technique.
Having security is the key justification for getting a letter of credit of any kind, especially for the seller. A letter of credit holder or seller in a global transaction must be certain that, if the payment terms are followed, they will get payment from the issuing bank. This isn't always the scenario, although. The business owner might at times be unsure of whether they would receive payment for his purchases or not. Numerous reasons, such as the issuing bank's dubious creditworthiness or the political or economic fragility linked to its location, can contribute to this anxiety.
To get the second letter of credit, the buyer must follow the same process. The buyer needs to track out a second bank that can confirm. The second bank is often the seller's country's correspondent bank.
It follows that a confirmed letter of credit will cost more and be more secure than one that has not. For an assessment of if a confirmed letter of credit is necessary for a particular transaction, the seller must perform a cost-benefit analysis. Using a payment option that is appropriate will help eliminate unsystematic risk as a whole.
How Do You Obtain a Confirmed Letter of Credit?
Step 1: The buyer or applicant visits the chosen bank to request the issue of a letter of credit. An opening or issuing bank is this particular institution.
Step 2: For the beneficiary or seller, who will get the Letter of Credit issued by the issuing bank of the buyer, there will be an advising bank (often an international bank). The advising bank will also check the name, product information, etc. to ensure the letter of credit is genuine.
Step 3: As banks are now participating in this procedure, the advising bank will share the letter of credit with the seller while assuring him or her that the money would be received.
Step 4: Following the seller's guarantee, the products will be dispatched in accordance with the information provided by the application or customer. Since the seller has already exported the items, the seller will now receive the bill of lading.
Step 5: The buyer must now provide the Bill of Lading to the Negotiating or Nominated Bank (International Bank), who will inspect all the shipping documentation and determine whether all the products were transported in accordance with the instructions. Finally, the payment to the seller or exporter will be made by the nominating bank.
Step 6: The nominating bank will also demand payment and share the shipping documentation with the issuing bank.
Step 7: The issuing bank will then share the paperwork with the buyer, requesting confirmation that all of the information is accurate and that all of the merchandise have been dispatched.
Step 8: At this point, the buyer pays the issuing bank, which then transmits the money to the designated or negotiating bank.
The customer must supply the financial institution that issued the card with particular records in order to obtain a letter of credit. regardless of whether the buyer is unable to pay, this letter informs the seller that payment will still be made. In this particular instance, the bank is put in danger, but an advisory bank will step in and make payments on behalf of the original bank.
Letters of Credit are frequently separated into two kinds, such as Commercial and Standby. whereas a standby letter of credit is a supporting instrument and commercial is the primary one.
What is an Unconfirmed LC?
Contrary to confirmed LC, an unconfirmed letter of credit refers to a documentary credit where the exporters or sellers do not acquire any additional or second guarantee from a second bank. To define unconfirmed, we can say that unconfirmed LCs are those where there is only a guarantee of payment by the original issuing bank. Here the second bank involves only acting as an intermediary to help process a transaction. There is no additional letter of credit confirmation from the secondary bank. Ensuring payment security is the most common reason for acquiring a letter of credit services as a means of payment in international transactions. Therefore, most documentary credits are unconfirmed LCs.
Difference Between Confirmed And Unconfirmed LC
From the above description, we get to know that the primary difference between confirmed and unconfirmed letter of credit is the confirmation of LC. When there is confirmation of letter of credit, it is a confirmed LC.
Here are the key points of differences between the unconfirmed and confirmed bank credit letter Keep reading to know:
1. Cost - The very first difference between confirmed lc and unconfirmed lc is the cost. The cost of unconfirmed LC is less compared to confirmed LCs as there are no confirming bank charges applied while the confirmed letters of credit are expensive due to the charges.
2. Main Institution - Under an unconfirmed LC, the original issuing bank is the main institution that provides an irrevocable payment guarantee to the exporter while a confirmed L/C not only contains an irrevocable guarantee from the issuing bank but from the second bank also, known as as a confirming bank. Thereby, these LCs are also known as confirming letter of credit. Both payment undertakings are separate from each other.
3. Amendments - Only the beneficiary i.e. the seller is authorized to make or request the changes in the unconfirmed LC via the applicant while in case of a confirmed credit letter, the second bank can also make changes or amendments directly to the issuing bank.
4. Process - The seller requests the payment from the issuing bank as the second bank only acts as a middleman while in a confirming LC, the LC confirmation process starts when the seller first approaches the confirming bank for the payment, and when it is done, it requests the payment from the issuing bank.
5. Bank to check the credibility - It is the issuing bank that checks the credibility of the importer in an unconfirmed bank credit letter while in case of a confirmed documentary credit, the confirming bank does the task for the issuing bank.
From the above points of key differences between confirmed vs unconfirmed letter of credit, we can conclude that a confirmed letter of credit meaning revolves around adding a second bank's confirmation to the credit. There are confirmation instructions in LC, making them an irrevocable and confirmed letter of credit.
Comparing confirmed LC vs unconfirmed LC, confirmed LCs are more secure than unconfirmed letters of credit but with additional costs. Therefore the seller must analyze the costs of the payment credit letters as per the requirements of your business to determine which type of letter of credit is suitable for your business.