Understanding Confirmed Letters of Credit: Key Insights, Benefits, and UCP 600 Guidelines

Confirmation of a letter of credit (LC) means that another bank, in addition to the issuing bank, promises to pay the beneficiary (exporter). This extra assurance is given by a bank usually located in the exporter’s country, known as the confirming bank.

How Documents Move Under a Confirmed Letter of Credit

When an LC is confirmed, the typical process involves:

1. Issuance: The issuing bank in the importer’s country issues the LC and sends it to the confirming bank in the exporter’s country.
2. Advising: The confirming bank advises the LC to the beneficiary adding confirmation.
3. Shipment and Documentation: The beneficiary ships the goods and prepares the necessary documents as required by the LC.
4. Presentation: The beneficiary presents the documents to the confirming bank.
5. Examination and Payment: The confirming bank checks the documents. If they are compliant, the confirming bank pays the beneficiary (or agrees to pay at a later date).
6. Forwarding Documents: The confirming bank forwards the documents to the issuing bank.
7. Reimbursement: The issuing bank reimburses the confirming bank after verifying that the documents are in order.

Who is the Confirming Bank and What is Its Role?

The confirming bank is the bank that adds its confirmation to the LC at the request of the issuing bank. Its roles include:

1. Guaranteeing Payment: Provides an additional guarantee of payment to the beneficiary.
2. Document Examination: Reviews the documents presented under the LC for compliance.
3. Payment: Pays the beneficiary if the documents are in order, regardless of whether the issuing bank has paid or not.
4. Advising: Communicates the LC to the beneficiary.

How to Identify Confirmation in an MT700 SWIFT Message

In an MT700 SWIFT message, which is used for issuing LCs, confirmation details are found in:

• Field 49 (Confirmation Instructions): Indicates whether the LC is available with the confirming bank and specifies the type of confirmation.
  • CONFIRM means the confirming bank is adding its confirmation.
  • MAY ADD means the bank may add its confirmation at its discretion.
  • WITHOUT means no confirmation is added.

Pros and Cons of Adding Confirmation to an LC

Benefits:

1. Risk Reduction: Lowers the risk of non-payment for the beneficiary as they have assurance from both the issuing and confirming banks. Incase issuing bank does not pay, confirming bank is already liable to make payment.
2. Trust: Increases the beneficiary’s confidence in the transaction, especially when the issuing bank is in a country with higher political or economic risks.
3. Financing: Facilitates access to pre-shipment or post-shipment financing as banks view confirmed LCs as less risky.

Cons:

1. Cost: Adds to the costs since the confirming bank charges a fee for its confirmation.
2. Complexity: Adds an additional layer of complexity in terms of documentation and procedures.

Relevant UCP 600 Article on Confirmation

Article 8 of UCP 600 deals with confirmation:

• Article 8 (a): Defines the obligations of the confirming bank, stating that it undertakes to honor or negotiate if the documents comply with the terms and conditions of the credit.
• Article 8 (b): Obligates the confirming bank to pay the beneficiary, irrespective of reimbursement from the issuing bank.

Example of a Confirmed Letter of Credit

Imagine Company A in India wants to purchase goods from Company B in Germany. Company A’s bank (issuing bank) issues an LC for $100,000 and requests a German bank (confirming bank) to confirm the LC. The confirming bank agrees and advises the confirmed LC to Company B.

1. Company B ships the goods and presents the documents to the confirming bank.
2. The confirming bank examines the documents and finds them compliant.
3. The confirming bank pays Company B.
4. The confirming bank forwards the documents to the issuing bank.
5. The issuing bank reimburses the confirming bank after its own document examination.

In the MT700 SWIFT message, Field 49 will show CONFIRM, indicating that the LC is confirmed.

This process ensures Company B receives payment even if there are issues with Company A or its bank, as the confirming bank has guaranteed the payment.

You may also refer below Youtube video for explanation –