Letters of credit are commonly-used payment instruments. They can either be confirmed or unconfirmed, and this decision impacts the level of nonpayment risk and amount of bank fees incurred by the U.S. exporter.
An unconfirmed letter of credit transfers payment risk from the foreign buyer to the foreign buyer’s bank (issuing bank). As a result, the U.S. exporter’s risk of nonpayment lies solely with the issuing bank. The U.S. exporter’s bank (negotiating bank) will submit complying documents to the issuing bank and then await payment upon document acceptance. This form of letter of credit is less expensive to a U.S. exporter than a confirmed version; however, the tradeoff is that the U.S. exporter is incurring non-U.S. credit risk.
Under a confirmed letter of credit, an additional bank (typically the U.S. negotiating bank) accepts the nonpayment risk of the non-U.S. issuing bank on behalf of the exporter. The payment instrument enables a U.S. exporter to effectively transfer payment risk from the foreign buyer to the foreign buyer’s bank to a U.S.-based bank (the U.S. exporter’s bank). As mentioned in the Faster Payments and Letters of Credit blog post, the U.S. exporter, in addition to incurring less risk, could receive payment from the negotiating bank as soon as the bank receives complying documents and therefore avoid the additional step of awaiting payment from the foreign bank. But a confirmed letter of credit is more expensive for U.S. exporters – the negotiating bank will charge them a fee based upon the credit strength of the issuing bank.
To confirm or not to confirm a letter of credit comes down to two important decision points. First, does the issuing bank maintain an acceptable risk rating? The negotiating bank can assist the U.S. exporter with this determination. Second, is faster payment remittance important to the U.S. exporter? Many U.S. exporters will incur the additional cost of the confirmation process for both the risk mitigation and accelerated payment benefits.
U.S. exporters who qualify for EXIM Export Credit Insurance can eliminate the risk of foreign buyer nonpayment due to commercial and political risks while offering competitive credit terms to their foreign buyers. Get in touch with an EXIM trade finance specialist to learn more.
