Confirmation of a letter of credit is defined as an undertaking from a bank in addition to the undertaking provided to the beneficiary by the issuing bank. Beneficiary would like to eliminate the default risk of the issuing bank as well as political risk by having the letter of credit confirmed to a bank which is located within the same country.
Confirming banks could only honour or negotiate a complying presentation. As a result beneficiaries have to present complying documents in order to obtain funds under letters of credit from either the issuing bank or the confirming bank. For this reason complying presentation is the key for the payment for both confirmed letters of credit and unconfirmed letters of credit.
Confirming banks take the default risk of the issuing bank as well as non-payment risk of the letter of credit originated from the political risk of the issuing bank’s country over themselves from the moment they have added their confirmation to the letters of credit. Even if a confirming bank could not receive any reimbursement from the issuing bank he has to make payment to the beneficiary against a complying presentation under the letter of credit which he has confirmed.
You might be wondering why a confirming bank would take such risks and confirm a letter of credit. The correct answer is very simple and straight forward; to make more profit.
Examples of Confirmation Fees:
Confirmation Fee Format 1: Exporters First Help Bank of New York confirms this credit and hereby undertakes to honor all drafts and documents presented in strict compliance with the credit terms. Our confirmation charges USD3.120,48.
Confirmation Fee Format 2: We shall charge our confirmation commission of 4,000000 PCT p.a., min. EUR200.00 p.q.
p.a. : per annum (12 months or 360 days)
p.q. : per quarter (3 months)
Who should pay confirmation fees?
According to letter of credit rules all fees and charges related to credits should be paid by the applicants. But we have learned long ago that this perfect world indication is not valid under real life situations. In most cases applicants pay only letter of credit issuance charges and let the banks collect all the remaining fees from the beneficiaries. As a result confirmation fees will be paid by the beneficiaries in most cases.
Confirmation fee can be defined as charges collected by the confirming banks against the risks they will be having to posses by confirming the letters of credit. As I have explained below confirming banks undertake two main risk factors with the confirmation: default risk of the issuing bank and political risk of the issuing bank’s country.