The Role of Banks in the Issuance and Confirmation of Letters of Credit

A buyer can agree to pay by letter of credit. That does not tell the exporter enough.

The exporter still needs to know which bank will issue the credit, whether that bank is acceptable, how the LC will be advised, where documents will be presented and whether another bank will add confirmation.

These roles determine where the payment undertaking sits and which institution carries the exposure after a complying presentation.

For companies arranging large trade transactions, understanding the difference between an issuing bank, advising bank, nominated bank and confirming bank is essential before accepting the payment terms.

The Four Bank Roles You Need to Understand

A documentary credit can involve several banks, but their obligations are not interchangeable.

Companies arranging a documentary credit can review Financely's documentary letter of credit services for importers and exporters for the broader issuance process.

The Issuing Bank Creates the Primary Documentary Credit Undertaking

The issuing bank opens the letter of credit at the request of its customer, known as the applicant.

The applicant is usually the importer or buyer under the underlying commercial contract.

Under UCP 600, the issuing bank becomes irrevocably bound to honor according to the credit from the time it issues the LC.

Its obligation is documentary.

The bank is not promising that the physical goods will be commercially satisfactory. It is undertaking to honor when the stipulated documents are presented and constitute a complying presentation under the credit.

That distinction is central to documentary credit law and banking practice.

The Issuing Bank Must Underwrite the Applicant Before Issuance

An LC is not simply a message sent through SWIFT.

When a bank issues a USD 10 million documentary credit, it takes contingent exposure to its customer.

If a complying presentation is made and the bank honors the credit, the bank expects reimbursement from the applicant.

Before issuance, a bank can review:

• historical financial statements;
• current management accounts;
• cash flow;
• existing leverage;
• working-capital requirements;
• existing trade finance facilities;
• underlying purchase contract;
• supplier information;
• goods or commodities being purchased;
• trade cycle;
• country exposure;
• sanctions risk;
• collateral;
• cash margin; and
• the applicant's ability to reimburse the bank.

Strong importers can obtain documentary credits under established revolving trade facilities.

Other applicants may be required to cash-collateralize part or all of the LC, pledge assets or provide other credit support.

A signed purchase contract does not itself create LC capacity.

Example of LC Issuance

Assume a U.S. importer purchases USD 8 million of industrial machinery from a German manufacturer.

The importer applies to its bank and provides the proposed LC terms.

The issuing bank approves the credit exposure and transmits the LC through authenticated banking channels.

The German bank advises the documentary credit to the manufacturer.

The manufacturer reviews the terms, ships the machinery and presents the required documents.

If those documents comply, the issuing bank is obligated to honor according to the availability and payment terms of the credit.

The Advising Bank Does Not Automatically Guarantee Payment

This distinction causes frequent confusion.

The advising bank receives the documentary credit from the issuing bank and communicates it to the beneficiary.

Under UCP 600, an advising bank that is not also a confirming bank advises the credit without undertaking to honor or negotiate.

By advising the credit, it signifies that it has satisfied itself as to the apparent authenticity of the communication it received and that its advice accurately reflects the credit.

That is valuable.

It is not the same as adding the advising bank's balance sheet to the payment obligation.

Why the Issuing Bank's Credit Quality Matters

An exporter receiving an LC is replacing or supplementing buyer credit risk with bank risk.

That only improves the transaction if the beneficiary is comfortable with the bank whose undertaking it is accepting.

Exporters and confirming banks can consider:

• financial strength of the issuing bank;
• regulatory status;
• jurisdiction;
• external ratings where available;
• country transfer risk;
• foreign-exchange availability;
• sanctions exposure;
• correspondent banking access;
• market appetite for that bank's risk; and
• tenor of the proposed exposure.

A documentary credit from a bank that the exporter cannot accept or finance can be commercially weaker than the buyer assumes.

Financely discusses this separately in Does the LC Issuing Bank Rating Matter?

What Is LC Confirmation?

Confirmation adds a second bank undertaking to the documentary credit.

Under UCP 600, a confirming bank adds its undertaking in addition to that of the issuing bank.

Once the bank adds confirmation, it becomes irrevocably bound according to the rules and the terms of the credit.

The exporter now has the benefit of two separate bank undertakings rather than relying solely on the issuing bank.

Financely's letter of credit confirmation service focuses on transactions where the beneficiary needs an acceptable bank to assume issuing-bank or country exposure.

What Risk Does Confirmation Address?

Confirmation is not primarily about whether the buyer wants to pay.

It is used when the beneficiary wants another bank to assume defined risk associated with the documentary credit.

The concerns can include:

• issuing-bank credit risk;
• issuing-bank insolvency;
• country risk;
• transfer restrictions;
• foreign-exchange availability;
• political disruption;
• payment restrictions; and
• the beneficiary's need for a bank undertaking in its own or another acceptable jurisdiction.

Confirmation can also improve financing.

An exporter holding a deferred payment undertaking from an acceptable confirming bank may have more options for discounting that obligation than if it held only the risk of an issuing institution with limited market appetite.

Confirmation Is Not Automatic

A buyer cannot simply write "confirmed LC" into the sales contract and assume any bank will add its confirmation.

The proposed confirming bank takes real credit exposure.

It can review:

• issuing-bank risk;
• country limit;
• transaction amount;
• tenor;
• currency;
• trade underlying the credit;
• sanctions and compliance exposure;
• availability of internal bank limits;
• reimbursement arrangements; and
• economics of taking the risk.

UCP 600 expressly recognizes that a bank authorized or requested to confirm a credit can decline to do so.

If it is unwilling to confirm, it can still advise the credit without adding its own payment undertaking.

Example of a Confirmed Letter of Credit

Assume a U.S. equipment exporter sells USD 15 million of machinery to a buyer in an emerging market.

The exporter is commercially comfortable with the buyer but does not want to hold USD 15 million of exposure to the issuing bank and its country for the payment tenor.

The issuing bank therefore authorizes or requests confirmation from a bank acceptable to the exporter.

The confirming bank reviews the issuing bank and country exposure. If approved, it adds its confirmation.

The exporter ships and presents compliant documents.

The exporter now holds the benefit of the confirming bank's undertaking in addition to that of the issuing bank for the complying presentation.

Who Pays the Confirmation Fee?

The commercial parties should agree this before the LC is issued.

Confirmation pricing is not fixed.

It can reflect:

• issuing-bank risk;
• country risk;
• tenor;
• transaction amount;
• currency;
• bank limit usage;
• reimbursement structure;
• capital consumption; and
• market conditions.

A 30-day exposure to a strong issuing bank will not price like a 360-day exposure to a weaker bank in a jurisdiction with transfer restrictions.

Where confirmation is economically material, the seller should incorporate the expected cost into the contract price or negotiate who bears it before accepting the payment terms.

The Nominated Bank Has a Different Role

The nominated bank is the bank with which the credit is available or, in a freely available credit, any bank.

Depending on the LC, the nominated bank may be authorized to pay at sight, incur a deferred payment undertaking, accept a draft or negotiate.

Nomination alone does not automatically force that bank to act.

Unless it is also the confirming bank or has otherwise expressly agreed to act, the nominated bank can retain discretion over whether to honor or negotiate.

Exporters should therefore distinguish between a bank being named in the LC and that bank having actually committed its balance sheet.

Confirmation Can Improve LC Discounting

Suppose an exporter receives a USD 10 million LC payable 120 days after shipment.

The exporter does not want to wait four months for cash.

After a complying presentation creates the relevant deferred payment obligation, the exporter may ask a bank to prepay or discount that future payment.

The financing bank prices the risk it is taking.

If the underlying obligation carries the confirmation of a bank the financier already accepts, discounting can be simpler or more economically attractive than financing an unconfirmed obligation from a weaker issuing institution.

Financely provides a separate letter of credit discounting service for exporters that need liquidity before an LC's contractual maturity.

Confirmation Does Not Protect Against Every Problem

A confirmed LC does not mean the exporter can ignore the documentary requirements.

The confirming bank's undertaking is still tied to a complying presentation.

Problems can still arise from:

• late shipment;
• late presentation;
• missing documents;
• inconsistent quantities;
• incorrect transport documents;
• insurance discrepancies;
• documentary conditions that cannot be satisfied;
• expiry problems; and
• other discrepancies under the credit.

Confirmation addresses bank and country exposure. It does not transform a discrepant presentation into a complying one.

Documentary Credits Are Independent From the Sales Contract

Banks deal with the documentary credit and the documents presented under it.

The LC is separate from the underlying sales contract even when the commercial contract is the reason the credit was issued.

The bank does not inspect whether the machine actually produces 500 units per hour or whether the commodity will later generate the buyer's expected margin.

It examines the required documents against the credit.

This is why the documentary requirements need to reflect what the seller can actually produce after performing the commercial contract.

Banks Examine Documents, Not the Physical Goods

This principle is particularly important for buyers.

A documentary LC is not an inspection service.

If a buyer needs independent verification of quantity, quality or performance before payment, the commercial parties should build an appropriate inspection document or certificate into the LC requirements.

Even then, the bank examines the presented certificate as a document. It does not independently repeat the physical inspection.

Good LC drafting therefore converts the buyer's genuine commercial controls into documentary conditions that are objective enough for banks to examine.

The Issuing Bank and Confirming Bank Underwrite Different Risks

Both banks can participate in the same documentary credit while making very different credit decisions.

The issuing bank principally underwrites its applicant.

It wants to know whether the importer can reimburse it after the bank honors the LC.

The confirming bank principally takes issuing-bank and country exposure under the documentary credit.

It wants to know whether it is comfortable adding its own independent undertaking and whether it can recover from the issuing bank under the agreed reimbursement structure.

What Happens if the Issuing Bank Fails?

This question illustrates the commercial purpose of confirmation.

Under an unconfirmed LC, the beneficiary principally relies on the issuing bank's documentary credit undertaking.

If the issuing bank becomes insolvent, payment can become exposed to that bank failure and any relevant legal or country restrictions.

Where an acceptable bank has properly added confirmation, the beneficiary also has the confirming bank's independent undertaking for a complying presentation.

That additional undertaking is precisely why exporters can be willing to accept documentary credits from issuing institutions or jurisdictions they would not otherwise be prepared to hold directly.

Confirmation Should Be Discussed Before the LC Is Issued

Exporters should not wait until after shipment to discover that the issuing bank cannot be confirmed.

Ideally, the issue is addressed while negotiating the sales contract and LC draft.

The exporter should establish:

• which issuing banks are acceptable;
• whether confirmation is mandatory;
• which confirming bank or banks are acceptable;
• who pays confirmation costs;
• whether bank limits are available;
• how long the exposure will remain outstanding; and
• whether the exporter expects to discount the LC after presentation.

This prevents a situation where the importer technically complies with the contract by opening an LC, but the exporter cannot accept or finance the bank risk behind it.

Silent Confirmation Is a Different Structure

Standard UCP confirmation is added upon the authorization or request of the issuing bank.

In some transactions, a beneficiary seeks separate protection from another bank even though the issuing bank has not requested formal confirmation.

This is commonly described as silent confirmation.

It is a separate contractual risk arrangement and should not be confused with formal confirmation under UCP 600.

The bank providing the protection determines the scope, recourse, documentary requirements and pricing of that separate undertaking.

Common LC Banking Problems

The Buyer Chooses an Unacceptable Issuing Bank

The exporter receives the LC but cannot obtain internal credit approval, confirmation or discounting against the issuer.

The Contract Requires Confirmation but No Bank Has Agreed to Provide It

The commercial parties assumed confirmation was an administrative step when it was actually a separate bank credit decision.

The Applicant Has No LC Capacity

A USD 20 million purchase contract does not mean the buyer's bank will issue a USD 20 million credit.

The Exporter Confuses Advising With Confirmation

Receiving an LC through a major international bank does not mean that bank has guaranteed payment.

The Documents Cannot Comply

A strong issuing bank and confirming bank cannot solve documentary conditions that the exporter cannot satisfy.

Nobody Checked Discounting Appetite

The exporter agrees to 180-day terms assuming it can receive immediate cash after shipment, then discovers that banks will not finance the issuing-bank or country exposure on acceptable terms.

Information We Need to Review an LC Transaction

A useful initial file generally includes:

• underlying purchase or sales contract;
• LC amount;
• proposed LC draft;
• applicant information;
• beneficiary information;
• proposed issuing bank;
• required confirmation, if any;
• goods or services being supplied;
• shipment schedule;
• payment tenor;
• applicant financial statements if issuance is being arranged;
• existing trade facilities;
• collateral position;
• required issuing-bank criteria; and
• any post-shipment discounting requirement.

This allows the issuance and beneficiary-side bank requirements to be addressed as one transaction rather than discovering incompatible bank expectations after the commercial contract is already binding.

What Financely Does

Financely provides paid trade finance advisory for companies arranging documentary letters of credit and related financing.

Depending on the mandate, our work can include:

• review of the underlying trade;
• LC facility sizing;
• applicant credit analysis;
• LC draft review from a financing perspective;
• issuing-bank identification;
• bank acceptability analysis;
• confirmation requirement analysis;
• confirming-bank identification;
• collateral and cash-margin analysis;
• deferred payment and usance structuring;
• discounting and refinancing analysis;
• lender-facing transaction package preparation;
• KYC and transaction-document coordination;
• term comparison; and
• coordination through underwriting and issuance.

Letter of Credit Bank Roles FAQ

What does the issuing bank do in a letter of credit?

The issuing bank issues the documentary credit at the applicant's request and becomes irrevocably bound to honor according to the credit when the requirements for a complying presentation are satisfied.

Does the advising bank guarantee payment?

Not merely because it advises the credit. Under UCP 600, an advising bank that is not also a confirming bank advises without an undertaking to honor or negotiate.

What is a confirming bank?

It is a bank that adds its own undertaking to the documentary credit upon the issuing bank's authorization or request. Its obligation is in addition to the issuing bank's undertaking.

Why would an exporter require confirmation?

The exporter may want protection against issuing-bank risk, country risk, transfer restrictions or other payment risks associated with relying solely on the issuing bank.

Can any bank confirm an LC?

A bank must be willing and able to take the exposure, and formal UCP confirmation is added upon authorization or request of the issuing bank. The proposed confirming bank still conducts its own credit and compliance review.

Can a bank refuse to confirm an LC?

Yes. UCP 600 expressly provides for a bank that has been authorized or requested to confirm but is not prepared to do so. It can advise the issuing bank accordingly and may still advise the credit without confirmation.

Does confirmation eliminate documentary risk?

No. The confirming bank's obligation still depends on a complying presentation. Exporters must satisfy the documentary conditions of the credit.

Does the issuing bank need collateral from the importer?

That depends on the applicant's approved trade finance line and credit profile. Banks can issue under unsecured or secured facilities, partial cash margin or full cash collateral depending on their underwriting.

Can a confirmed LC be discounted?

Potentially. A future payment undertaking under a complying presentation can be considered for prepayment or discounting. Confirmation by an acceptable bank can materially affect the financier's risk analysis and pricing.

Is the nominated bank always obligated to pay?

No. Nomination by itself does not automatically create an obligation to honor or negotiate unless the nominated bank has expressly agreed or is also bound in another capacity, such as as a confirming bank.

Need to Issue or Confirm a Letter of Credit?

If your company needs a documentary LC for an import or export transaction, the bank structure should be established before the transaction reaches shipment.

Financely can assess the applicant, proposed issuing bank, beneficiary requirements, confirmation needs, collateral position and any post-shipment financing requirement.

Submit the contract value, LC amount, buyer and seller jurisdictions, proposed bank if known, payment tenor and required confirmation criteria. Where the transaction fits our mandate requirements, we can quote the advisory and arrangement work required.