You Want a Letter of Credit, Really? Part 4

How do L/C Confirmations facilitate Trade Credit…

 

Many corporations adopt a policy that all export letters of credit ("L/Cs") received must be confirmed by their banker(s) in order to cover the payment and country risks of the L/C issuing banks.

What does Confirmed mean?

In layman’s terms, and believe me, you will want in it simple English, when issuing an L/C, the Buyers Bank stands in the place of the buyer in a foreign or domestic country.  This is not always an acceptable risk, especially in this day and age where banks are propped up by governments.  In addition, due to onerous compliance requirements, many large global banks are downsizing their correspondent Bank relationships.  So second and third tier banks in Pakistan, or Cambodia or the Middle East will now find it hard to do business.

This is where confirmation comes in.  A confirmed irrevocable letter of credit enables a domestic bank to stand in place of the buyers bank, with permission from the buyers bank, creating a post-shipment domestic transaction with respect to the seller, and a pre-shipment foreign transaction with respect to the buyer and the buyer's bank.

Why is this Important?

Think insurance.  In a risky world where trade is done with fewer banks, having your foreign receivables turn into cash in a non recourse basis is golden.  A confirming bank will take the risk of nonpayment and for this it charges certain fees and may also retain margin from the issuing bank depending on the deal with the issuing bank.

What is silent confirmation?

 In some countries, L/C issuing banks do not prefer their L/Cs to be confirmed because they regard such an action as potentially having a negative impact on their credit standing.  For example, there are no governmental regulations in China that prevent Chinese banks from having their L/Cs confirmed. This is purely a cultural matter. It is considered an affront to the creditworthiness of the issuing bank and/or the economic policies of the government to ask them to have their L/Cs confirmed by someone else. It is really just a matter of pride that Chinese banks don't (usually) ask for their L/Cs to be confirmed.

Accordingly, in order to meet market demand, it is not uncommon for banks to provide a service called " silent confirmation ". Some banks call it "payment guarantee" or "commitment to purchase", which essentially mean similar "without recourse" financing arrangements between the silent confirmer and the beneficiary.

The exporter's bank incurs a definite payment undertaking in addition to that of the L/C issuing bank without the instructions/authorizations of the issuing bank. Accordingly, it undertakes to the exporter that it will honor the exporter's drawing(s), either by way of "making immediate payment" or "undertaking an obligation to make payment" on a "without recourse" basis provided that compliant documents are presented.

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