What is a Confirmed Letter of Credit
A confirmed letter of credit is a letter of credit with a second guarantee obtained by a borrower in addition to the first letter of credit. A confirmed letter of credit is typically used when the issuing bank of the first letter of credit may have questionable creditworthiness and the seller seeks to get a second guarantee to assure payment. If the first letter of credit is not backed by a second guarantee then it may be considered unconfirmed.
BREAKING DOWN Confirmed Letter of Credit
A confirmed letter of credit requires the backing of more than one bank by a buyer of goods in a domestic or international transaction. A confirmed letter of credit may be required by a buyer in a transaction if the seller is not satisfied with the creditworthiness of the first letter of credit. A confirmed letter of credit adds to the credibility of the buyer and helps to decrease the risk of payment default for the seller.
First Letter of Credit
A letter of credit is commonly needed in business transactions requiring substantial payment for goods or services. Instead of requesting an advance payment, the seller may require that the buyer obtain a letter of credit for the balance of the payment to be owed at the time of full delivery. A buyer must work with a bank to obtain the first letter of credit. This requires a full credit application similar to the credit application for a loan. If the seller is approved for the letter of credit the bank documents that they are willing to pay the seller the stated amount if the buyer defaults at the time of payment. The terms of the letter of credit will typically structure the payment as a loan for the buyer.
If the buyer is unable to make the payment to the seller at the time when the funds are due then the bank will issue the payment as a loan to the buyer. Upon receiving the letter of credit, the buyer also agrees to the bank’s loan terms. Terms of the loan if required will included a stated interest rate and payment schedule as well as other disclosures regarding repayment.
If the seller is satisfied with the first letter of credit they may accept it as an unconfirmed letter of credit. Unconfirmed letters of credit require the support of only one lending bank.
Obtaining a Second Letter of Credit
Obtaining the second letter of credit confirms the first letter of credit and qualifies it as a confirmed letter of credit. The process for obtaining a second letter of credit is the same as the first letter of credit. The buyer will have to find a second bank to back their purchase in the case of defaulted payment. The buyer will need to go through the same letter of credit process again to be approved for a second letter of credit. The structuring of the funds for the second letter of credit will typically take into consideration the terms of the first letter of credit as well. In some cases, the seller may only require that the second letter of credit represent a percentage of the total due since it is in addition to the credit offered by the first bank.