Confirmed Letter of Credit (L/C)

A Confirmed Letter of Credit (L/C) is a widely used trade finance instrument that provides an additional layer of payment security in domestic and international trade transactions. It involves a commitment by two banks—the issuing bank and a confirming bank—to honour payment to the exporter, provided that all documentary conditions specified in the credit are fully complied with. In banking and finance, a confirmed L/C plays a critical role in mitigating counterparty, country, and bank risks. Within the Indian economy, confirmed letters of credit are particularly significant in supporting exports, facilitating cross-border trade, and enhancing confidence in international commercial transactions.
A confirmed L/C is especially relevant where the exporter has limited confidence in the creditworthiness of the issuing bank or the economic and political stability of the importing country.

Concept and Meaning of a Confirmed Letter of Credit

A letter of credit is a written undertaking by a bank on behalf of an importer to pay the exporter upon presentation of compliant documents. A confirmed letter of credit goes a step further by adding the independent guarantee of a second bank, usually located in the exporter’s country.
In this arrangement:

• The issuing bank opens the L/C at the request of the importer.
• The confirming bank adds its confirmation, assuming an irrevocable obligation to pay.
• The beneficiary (exporter) gains assurance of payment from both banks.

Once confirmed, the exporter is insulated from risks associated with the issuing bank’s insolvency, foreign exchange restrictions, or political disruptions in the importer’s country.

Legal and Regulatory Framework

Confirmed letters of credit operate under internationally accepted rules, primarily the Uniform Customs and Practice for Documentary Credits (UCP 600) issued by the International Chamber of Commerce. These rules standardise documentary requirements, bank responsibilities, and dispute resolution practices.
In India, confirmed L/C transactions are regulated under the broader framework of foreign exchange and banking regulations administered by the Reserve Bank of India. Authorised dealer banks must comply with prudential norms relating to trade finance, exposure limits, and anti-money laundering requirements.
Indian banks engaged in confirmation services also adhere to capital adequacy and risk management standards influenced by Basel III norms.

Process and Mechanism of a Confirmed L/C

The operational flow of a confirmed letter of credit follows a structured sequence:

• The importer and exporter agree on trade terms requiring a confirmed L/C.
• The importer requests its bank to issue the L/C in favour of the exporter.
• The issuing bank transmits the L/C to a bank in the exporter’s country.
• The advising bank, after due assessment, adds its confirmation and becomes the confirming bank.
• The exporter ships the goods and submits documents to the confirming bank.
• Upon verification of compliance, the confirming bank makes payment or accepts a draft.
• The confirming bank claims reimbursement from the issuing bank.

This dual-bank commitment significantly enhances transactional certainty for exporters.

Importance in Banking and Finance

In banking and finance, confirmed letters of credit are a vital risk mitigation tool. They transform commercial risk into bank risk, which is generally more manageable and quantifiable.
Key financial significance includes:

• Reduction of credit risk for exporters.
• Mitigation of country and transfer risk in cross-border trade.
• Improved access to trade finance, as confirmed L/Cs can be discounted.
• Enhanced liquidity management for exporters through assured cash flows.

For banks, confirmation fees represent a source of non-interest income, while also requiring robust credit assessment of the issuing bank and country risk.

Role in the Indian Economy

Confirmed letters of credit play a crucial role in promoting India’s export-led growth strategy. Indian exporters, particularly in sectors such as textiles, pharmaceuticals, engineering goods, and information technology-enabled services, often deal with buyers in emerging or high-risk markets.
By using confirmed L/Cs:

• Indian exporters gain confidence in entering new and unfamiliar markets.
• Small and medium exporters overcome constraints related to buyer creditworthiness.
• Export competitiveness improves due to reduced payment uncertainty.

Confirmed L/Cs also support India’s balance of payments by facilitating smoother and more reliable export receipts.

Relevance for Indian Banks

Indian banks act both as issuing banks for imports and confirming banks for exports. When confirming foreign L/Cs, banks must evaluate:

• The financial strength of the issuing bank.
• Sovereign and political risk of the importer’s country.
• Compliance with international sanctions and trade regulations.

Public sector and private sector banks in India actively participate in confirmation arrangements, often in collaboration with international correspondent banks. This strengthens India’s integration with global financial markets.

Advantages of Confirmed Letters of Credit

Confirmed L/Cs offer several advantages in trade and finance:

• High payment security for exporters.
• Protection against issuing bank default.
• Elimination of country risk affecting payment.
• Facilitation of pre- and post-shipment finance.
• Improved trust in international trade relationships.

These benefits make confirmed L/Cs particularly valuable in volatile economic environments.

Limitations and Criticism

Despite their advantages, confirmed letters of credit have certain limitations. The cost of confirmation can be significant, especially when country or bank risk is high. These costs are often borne by the importer or exporter, depending on contractual terms.
Additionally, confirmed L/Cs are document-based rather than goods-based, meaning banks deal strictly with documents and not the actual quality or condition of goods. Documentary discrepancies may still delay or jeopardise payment.
Over-reliance on L/Cs may also reduce flexibility compared to open account trade, which is increasingly preferred in low-risk markets.