Definition:
A confirmed letter of credit is an instrument that facilitates the international transactions between the willing buyer and willing seller, who live in geographically distanced places and in almost all cases in two different countries of the globe.
Both the parties to the transactions are in fear that they will not be able to successfully complete their transaction in case of default by either party.
For the same reason, there should be a third party able to transact successfully per the agreement’s terms and conditions.
This role is always played by the banks and other financial institutions located in both countries.
In a letter of credit (LC) the bank or financial institution takes the guarantee of payment that in case of default by the customer the guaranteeing organization will pay the required amount to the other party.
But in the confirmed letter of credit for the minimization of this risk, the guarantee is taken from the second bank or any other financial institution as well.
It means in case of default by the party as well as the guaranteeing bank there will always be the second bank in order to pay the required amount to the other party for the transaction.
Thus the confirmed letter of credit is considered one of the most secured forms of the contract because the two banks back surety at the same time.
Purpose
The main purpose of the letter of credit is to secure the payment of either party in case of default.
This instrument makes possible or enhances the reliability of international business because a person being a seller or buyer cannot easily rely on the person and dispatch its goods to the buyer or the buyer cannot be willing to pay for the goods before arrival.
A bank or a financial instrument comes in to facilitate both parties to the transaction.
There is also a risk that the bank or a financial institution may also default thus in order to enhance the security of the transaction one can enter into the confirmed letter of credit.
Through this, the other party is more satisfied that there is another bank to secure the payment in case of default by one bank.
Types:
Two types of instruments are confirmed and unconfirmed letters of credit.
If the letter of credit confirms by the confirmation of the second bank to the beneficiary that in case of default by issuing the bank it will surely facilitate the payment transaction as per the agreed terms.
If the letter of credit does not add any surety to the beneficiary in case of default by the issuing bank which means no one is responsible for making the required payment then this payment structure is called an unconfirmed letter of credit.
Conclusion
Every economy around the globe has its own business dynamics. Business organizations working under strict laws and regulations are considered less risky to transact business because they work under strict laws and regulations where the state organizations keep an eye on the business operations of their business entities.
Every business entity operates under the strict ethical rules set by the state. Business organizations working in developing and underdeveloped countries are riskier, there is always a risk of default or a risk to shipping substandard products.
The laws and regulations in these countries are not regulated properly so there is always a risk that the business entities will either default in making payments or shipment of low-standard products.
Thus in order to ensure the quality of the products and proper, timely and complete payment for goods received, the business organizations, as well as the individuals, have to trust the instruments made by the banks or financial institutions.
This gives both parties a complete surety that the banks and other financial institutions will fulfill their respective promises.
The buyer is completely assured of the delivery of high-quality goods as per the description of the transaction however the supplier is given surety for the full and timely payment for the goods shipped.
In order to provide more security to the transaction, one can enter into the confirmed letter of credit because it gives double surety to the supplier that in case of default by the issuing bank there is always a second bank at the back that will make payment in case of default by the first bank.
