DRAFT Improving the SMEs Access to Trade Finance
in the OIC Member States
15
In the event that the exporter is not sufficiently confident of the ability of the issuing bank to
make payment against compliant documents, either due to doubt about the bank’s standing, or
perhaps concern about the stability of the importing country, the exporter can request that the
L/C be confirmed. This is a process whereby another bank (usually the exporter’s bank, or at
minimum, a well-known international bank) is asked, for a fee, to add its own independent
payment promise to the L/C, effectively allowing the exporter to claim monies from the
confirming bank, and thus eliminating any risk of non-payment by the importer or the
importer’s bank, or any risk related to the stability of the importing country which could
prevent the exporter from collecting any monies due.
Confirmed documentary credits offer the greatest level of protection for the exporter provided
again that the exporter is fully compliant with the terms and conditions of the letter of credit.
In that instance, the exporter can effectively bypass any risk associated with doing business
with the importer, the importer’s bank and the importer’s country, arranging to receive
payment from a trusted international bank, usually the exporter’s own bank, and usually in the
home country of the exporter, or at least, in a stable financial centre where there is no risk of
non-payment against fully compliant documents.
Confirmation of a letter of credit can be expensive, particularly when the risk is high, but it is
often the only way certain types of trade transactions can take place, and as such, various
international institutions including those linked to OIC Member States, will provide guarantees
to enable trusted international banks to confirm the letters of credit issued by banks that are
located in high-risk or high-volatility markets, or indeed, that are themselves not completely
solid.
The use of letters of credit, including confirmed credits, enables two situations: credit
enhancement and risk transfer. Credit enhancement refers to the improvement in credit
quality (and the attendant lowering of risk) resulting from a shift of payment obligation from
the importer to the issuing bank: most commonly a situation where the bank is more
established and probably has a higher credit rating than the importer client. Risk transfer,
similarly, refers to the outcome under an L/C (and other trade finance mechanisms) where the
risk is shifted from one party to another. A confirmed letter of credit allows the exporter to
benefit from a shift in risk, away from the issuing bank and the importing country, to the
confirming bank, usually located in the exporter’s home country.
Confirmed credits also provide protection for the importer or buyer, in that no payment is
effected unless the exporter demonstrates, by submitting the proper documentation, that all
required terms and conditions have been met.
Letters of credit, as other traditional mechanisms such as documentary collections, are
governed, or at minimum, their use is guided by, a long-established set of rules called the UCP,
or the Uniform Customs and Practice for Documentary Credits, first published in 1933 by the
International Chamber of Commerce in Paris. The rules are complemented by various guiding
publications and opinions on interpretation, published by the ICC Banking Commission and
others.
The existence of these rules, that have been revised and updated roughly once every ten years,
is fundamental to the wide acceptance and success of letters of credit across the globe and