About 600 years ago it was common knowledge that if you sailed west from Europe, either the ocean would abruptly end and you would fall off the end of the earth, or there were man-eating dragons waiting for you for lunch. Their lunch, not yours. (See our note about this in our PS.)
People living in that era had it tougher because the facts themselves were in short supply. Today there are enough facts around to satisfy everyone if they bother to look.
That’s why it’s so amazing that misinformation still spreads even amongst professionals in a field.
How to Make Some Bankers and Traders Squirm about LC’s
This is a study as much in human nature and how myths occur, as it is a consideration of LC details. This happens in business, in politics, everywhere. Large groups of people can reach erroneous conclusions because of the tendency, if one hears a “fact” often enough, to believe that it’s true, and to go forward without thinking it through.
In the foreign trade world, the phrase ‘confirmed LC’, found and required in most trading agreements and contracts, means something. The question is what, exactly it means.
You might ask your banker what it means sometime and see what he says. If he’s a front line relationship manager, he’ll probably mumble something about a confirmed LC is safe and an unconfirmed LC is somehow more risky.
By now, you’re probably sitting on the edge of your seat to find out the truth. Here’s what ‘confirmed LC’ means: A second guarantee, in addition to a letter of credit, that commits to payment of the letter of credit. A confirmed letter of credit is typically used when the issuing bank of the letter of credit may have questionable creditworthiness and the seller seeks to get a second guarantee to assure payment. (Investopedia)
Further: Confirmation is a security tool for exporters. Confirmation eliminates country risk and insolvency risk of the issuing bank. (Letterofcredit.biz)
So you will reasonably want a LC confirmation if there are possible issues with the bank or country involved. But when, as we’ve seen surprisingly often, an agreement specifies payment by “a confirmed LC issued by a top 25 bank”, the seller is basically saying that even a top 25 bank needs another bank to stand behind it and guarantee payment. Can you think of a reason why you would need to have any investment grade (BBB or better) bank’s LC confirmed? We can’t. Unless you’re worried the entire banking system has banks that are going to start exploding like firecrackers. If so, there are probably bigger things to worry about.
In the world that we see, confirming any and every letter of credit is rather like killing a mosquito with a sledge hammer. It’s a tool that has its uses, yes, but is unnecessary for many letters of credit.