By default, most of the Letters of Credit issued are irrevocable and unconfirmed. The issuing bank cannot attach a confirmation to the primary documentary credit. Any letter of credit that is issued without an advising bank’s confirmation is considered as the unconfirmed letter of credit. An unconfirmed letter of credit is simple to execute and cheaper as compared to a confirmed letter of credit. However, unconfirmed LCs offer lesser financial security for the sellers too.
What is an Unconfirmed Letter of Credit
A letter of credit without an advising bank’s confirmation is termed an unconfirmed letter of credit. A buyer’s bank issues a letter of credit after appraising the creditworthiness of the buyer. In some cases, the seller may not be satisfied with the LC arrangements and may ask for additional confirmation.
In regular international trades among the trade partners, the sellers may not insist on the additional confirmation. Any irrevocable letter of credit that does not accompany an advisory bank’s confirmation is by default unconfirmed LC.
How Does Unconfirmed Letter of Credit Work?
The application and approval process for the unconfirmed letter of credit is like an ordinary documentary credit. The buyer approaches the bank for issuing a letter of credit in the seller’s favor. The terms and conditions for the LC remain consistent with the trade deal between the two parties.
Once the trade contract is confirmed, the issuing bank issues the letter of credit after appraising the applicant’s creditworthiness. The seller’s bank acts as the intermediary for the clearance of the unconfirmed letter of credit. The advisory bank’s role is limited to the fund clearance only with an unconfirmed LC as opposed to in the case of the confirmed LC. The Advisory bank also cannot advise on any LC terms in favor of the seller. An irrevocable LC cannot be altered by default without the applicant’s consent.
Differences between a Confirmed and Unconfirmed Letter of Credit
By default, a letter of credit is irrevocable and unconfirmed. The seller may ask the buyer to issue a confirmed letter of credit. Characteristics of both types of documentary credit remain the same as both types work as a financial guarantee for the seller. Some certain features and requirements distinguish the unconfirmed letter of credit from the confirmed LC.
| Feature | Unconfirmed Letter of Credit | Confirmed Letter of Credit |
| Approval and Issuance | The buyer’s issuer bank is the main financial institution. | Buyer’s issuer bank issues the first LC, and the advisory bank issues the confirmation. |
| Financial Security | The issuer bank is the guarantor with an irrevocable unconfirmed LC. | The advisory bank provides the additional financial guarantee and credit confirmation. |
| Costs | Unconfirmed LCs are cheaper with lower total costs. | Confirmed LCs require issuing two separate LCs hence cost more than an unconfirmed LC. |
| Alteration and Amendments | Any amendments can be requested by the beneficiary only. | The beneficiary and the Advisory bank can ask for alterations in both letters of credit. |
| Bank Advisory | Seller’s advisory bank does not offer any advisory role and limits only to the payment processing. | The advisory bank provides the advisory role and may ask for certain terms and alterations in the confirmation LC. |
A confirmed letter of credit offers more financial security to the beneficiary. It involves two banks with two separate LCs issued. An unconfirmed LC on the other hand is a simpler and convenient option for many. Unconfirmed LCs come with lower costs and quick processing as compared to the confirmed LC. The irrevocability clause with the unconfirmed LC provides financial security to the buyer and the seller.
The Approval Criteria for Unconfirmed Letter of Credit
An unconfirmed letter of credit requires the same approval criteria as for the bank loan facilities. The issuer bank appraises the applicant’s creditworthiness and approves the documentary credit limit. The issued letters of credit for any applicant are by default an unconfirmed form of documentary credit. If the seller demands, the buyer may pursue confirmation of the unconfirmed LC from an Advisory bank. The seller’s advisory bank plays only the facilitator’s role with an unconfirmed LC. Unlike a confirmed LC, the advisory bank does not appraise the issuer bank and the applicant. The total costs associated with an unconfirmed LC are lower than a confirmed LC.
Example
Suppose a buyer company Blue Tech in the UK approaches another company Green Star in the US. Once the trade deal is finalized, the Buyer will approach the bank for issuance of a Letter of Credit. The issuer bank will issue an unconfirmed and irrevocable LC in favor of the seller after appraisal. The Seller will then proceed with the trade order and after fulfillment of certain terms proceed for the LC. The seller’s advisory bank will facilitate only the payment process.
Advantages of an Unconfirmed Letter of Credit
Unconfirmed documentary credits also come with certain advantages to both parties involved in international trade.
- All letters of credit by default are unconfirmed, hence come with an understanding for both parties in international trade.
- Unconfirmed LCs are easier to proceed with and costs less than confirmed LCs.
- The sellers may be at advantage with a better bargain for contract prices as compared to the confirmed LC.
- Both parties are protected with issuing bank’s guarantee and the irrevocable feature of the unconfirmed LC.
Disadvantages of an Unconfirmed Letter of Credit
An unconfirmed letter of credit is a regular documentary credit instrument that offers certain benefits to both parties. However, it comes with some limitations as well:
- Unconfirmed LCs are less secure in financial terms than the confirmed LCs.
- Unlike confirmed LCs, the advisory bank does not provide the advisory role to the seller.
- The risk of default with an unconfirmed letter is significantly higher.
- The issuer bank may not cover for political and macroeconomic risk with unconfirmed LCs that do not directly relate to the buyer.
- The seller can only ask for alterations through the buyer’s issuing bank and the advisory bank cannot play any role in such arrangements.
Conclusion
An unconfirmed letter of credit is a convenient and regular form of documentary credit. It is easier to proceed and simpler to execute than a confirmed Letter of Credit. The irrevocable feature and issuer bank’s appraisal offer financial security to the seller. However, unconfirmed LCs come with a lower financial guarantee for the seller without active participation by the advisory bank.
