A letter of credit is a document that is used in international transactions. It is issued by the bank of the purchasing company to guarantee to the selling company that the buying company has the money available to transfer to the seller once the purchased goods are received. A confirmed letter of credit is equivalent to a second opinion — some sellers require one from a second institution to guarantee that the money is available.
The seller of the goods typically has its own bank that is involved in the transaction. The original letter of credit from the issuing bank is sent to the bank that is representing the seller. The two banks work together to foster the transaction between the buyer and the seller in the international transaction. Both banks stay involved throughout the process. The involvement of both banks include the original letter of credit and the confirmed letter of credit.
Essentially, a confirmed letter of credit involves two banking or financial institutions that hold money for the business that is purchasing the goods. This is a double guarantee that, if in fact one of the banks cannot cover the cost of the goods, the second institution will hold enough money to cover the amount of goods that the purchaser is buying.
A letter of credit is typically required by the seller of the goods to guarantee that it will receive the money that is due once it ships the goods. This document also protects the buyer because it do not have to pre-pay for the goods until it receives confirmation that the goods have actually been shipped. The confirmed letter of credit is simply added insurance for both parties that the goods will be paid for and received according to the agreement.
A confirmed letter of credit is not only double insurance, but may be a necessity for transactions involving certain countries. Countries that are experiencing political or economic instability may require that a second financial institution be involved in each of its international deals, rather than just relying on the original letter of credit.
Once the letter of credit and confirmed letter of credit are received, the seller typically ships the goods. Once the purchaser’s bank receives confirmation that the goods have been shipped, then the funds are released according to the terms and conditions set in the letter of credit and the supporting document.