What is the difference between LC and confirmed LC?

Navigating the Nuances: Understanding the Difference Between a Letter of Credit (LC) and a Confirmed Letter of Credit

In the complex world of international trade, mitigating risk is paramount. A Letter of Credit (LC) is a widely used financial instrument designed to provide security for both buyers and sellers. However, not all LCs are created equal. While the standard LC offers a level of assurance, a Confirmed Letter of Credit takes that security a step further, offering enhanced protection, particularly in volatile situations. Understanding the key differences between these two is crucial for exporters looking to safeguard their transactions.

At its core, a Letter of Credit is a commitment from a bank (the issuing bank) to pay a seller (the beneficiary) a specific sum of money, provided the seller fulfills the precise terms and conditions stipulated in the LC document. This process typically involves the importer (the applicant) arranging the LC with their bank. The issuing bank then notifies the exporter’s bank (the advising bank) about the LC, and the advising bank informs the exporter.

So, where does the “confirmation” come in? The critical distinction lies in the addition of a second bank’s guarantee. A Confirmed Letter of Credit involves a second bank, usually located in the exporter’s country, adding its own irrevocable promise to pay the seller, in addition to the issuing bank’s promise. This second bank is known as the confirming bank.

Think of it this way:

• Letter of Credit (LC): Imagine a single lock on a door. The issuing bank holds the key.
• Confirmed Letter of Credit: Imagine two locks on the door. The issuing bank holds one key, and the confirming bank holds the other. Both keys must be turned for the door (payment) to open.

Why would an exporter request a Confirmed Letter of Credit?

The primary reason for seeking a confirmed LC boils down to mitigating risk, specifically related to:

• Issuing Bank’s Financial Stability: Exporters might worry about the financial health of the issuing bank in the importer’s country. If the issuing bank were to become insolvent or face financial difficulties, the exporter’s payment could be jeopardized. The confirming bank acts as a safety net, guaranteeing payment even if the issuing bank defaults.
• Country Risk (Political and Economic Instability): The importer’s home country might be experiencing political unrest, economic instability, or exchange control regulations that could hinder the issuing bank’s ability to honor the LC. The confirming bank, usually located in a more stable country, mitigates this risk. For example, sanctions imposed on the importer’s country could prevent the issuing bank from making the payment. The confirming bank, being subject to different jurisdictions, might be able to fulfill the payment regardless.
• Currency Convertibility and Transfer Risk: Some countries have restrictions on converting local currency into foreign currency or transferring funds abroad. A confirmed LC helps overcome these hurdles, as the confirming bank will typically be able to pay in a freely convertible currency.

In Conclusion:

While a standard Letter of Credit offers a considerable level of security in international trade, a Confirmed Letter of Credit provides an extra layer of protection against the potential risks associated with the issuing bank or the importer’s country. By understanding the nuances of these two instruments, exporters can make informed decisions and choose the option that best safeguards their financial interests in the global marketplace. While a confirmed LC comes with added costs (confirmation fees are charged by the confirming bank), the peace of mind and reduced risk often outweigh the expense, particularly when dealing with unfamiliar buyers or politically and economically volatile regions.