What Is a Standby Letter of Credit.

Standby Letter of Credit: (SBLC) Operates like a Commercial Letter of Credit, except that typically it is retained as a “standby” instead of being the intended payment mechanism. In other words, this is a LC which is intended to provide a source of payment in the event of non-performance of contract.

A letter of credit (LC), also known as a documentary credit or bankers commercial credit, or letter of undertaking (LoU), is a payment mechanism used in international trade to provide an economic guarantee from a creditworthy bank to an exporter of goods. Letters of credit are used extensively in the financing of international trade, when the reliability of contracting parties cannot be readily and easily determined. Its economic effect is to introduce a bank as an underwriter that assumes the counterparts risk of the buyer paying the seller for goods.
https://en.wikipedia.org/wiki/Letter_of_credit

Also called a standby credit. An instrument typically issued by a bank which undertakes to pay one party to a contract (the beneficiary) when the other party has failed, or is alleged to have failed, to perform the contract. The beneficiary is usually the purchaser of goods or services under the contract. A standby letter of credit is often payable simply on the beneficiary’s presentation of a written demand.

The issuer’s undertaking to pay creates a primary obligation on it, which is independent of the underlying contract. A standby letter of credit is therefore similar to an on demand bond but differs from a true guarantee (that is, a contract of suretyship). The obligation of a guarantor to make payment under a true guarantee is a secondary obligation dependent on the beneficiary establishing that the primary obligor is in breach of the underlying contract.
https://uk.practicallaw.thomsonreuters.com/3-107-7308?transitionType=Default&contextData=(sc.Default)&firstPage=true#:~:text=letter%20of%20credit-,Related%20Content,failed%2C%20to%20perform%20the%20contract.

What Is a Standby Letter of Credit (SLOC)?

A standby letter of credit (SLOC) is a legal document that guarantees a bank’s commitment of payment to a seller in the event that the buyer–or the bank’s client–defaults on the agreement. A standby letter of credit helps facilitate international trade between companies that don’t know each other and have different laws and regulations. Although the buyer is certain to receive the goods and the seller certain to receive payment, a SLOC doesn’t guarantee the buyer will be happy with the goods. A standby letter of credit can also be abbreviated SBLC.
https://www.investopedia.com/terms/s/standbyletterofcredit.asp

How a Standby Letter of Credit Works?

How a Standby Letter of Credit Works. A SLOC is most often sought by a business to help it obtain a contract. The contract is a “standby” agreement because the bank will have to pay only in a worst-case scenario. The bank agrees to reimburse the third party in the event that its client fails to complete the project.

Types of Standby Letter of Credit.

The two main types of SBLC are:

1. Financial SBLC.

The financial-based SBLC guarantees payment for goods or services, as stipulated in the agreement. For example, if a crude oil company ships oil to a foreign buyer with an expectation that the buyer will pay within 30 days from the date of shipment, and the payment is not made by the required date, the crude oil seller can collect the payment for goods delivered from the buyer’s bank. Since it is a credit, the bank will collect the principal plus interest from the buyer.

2. Performance SBLC.

A performance-based SBLC guarantees the completion of a project within the scheduled timelines. If the bank’s client is unable to complete the project outlined in the contract, then the bank promises to reimburse the third party to the contract a specific sum of money.

Performance SBLCs are used in projects that are scheduled for completion within a specific timeline, such as construction projects. The payment serves as a penalty for delays in the project’s completion, and it is used to compensate the customer for the inconvenience caused or to pay another contractor to take over the project.

Types of Standby Letters of Credit.

Understanding the types of standby letters of credit such as performance, advance payment, bid bond, counter, financial, insurance and commercial standby letters of credit.

What are the Main Types of Stand-by Letters of Credit?

A standby letter of credit is a bank’s undertaking of fulfilling the applicant’s obligations.

A standby letter of credit is issued as a collateral and is therefore not intended to be used as a primary payment method unlike a commercial letter of credit.

Standby letters of credit will be liquefied only if the applicant default of its responsibilities under the underlying contract.

Standby letters of credit can be seen as a mixture of “commercial letters of credit” and “demand guarantees”. Standby letters of credit have the same structure as the commercial letters of credit, whereas their role is almost identical to the demand guarantees.

Key-takeaway.
A standby letter of credit means a bank-issued document that protects a seller if a buyer doesn’t pay for goods or services.
SLOCs are used in both domestic and international trade. Since they help carry out foreign trade smoothly, they are more frequent in international trade
.
SLOC is a credit facility as such the buyer who has issued a SLOC requires to pay the bank fees and interest over the due amount.

Standby letters of credit structure.
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A typical standby letter of credit consists of an undertaking by a bank to pay a named beneficiary a specific sum if the beneficiary presents the bank with the documents listed in the standby letter of credit.

Types of Standby Letters of Credit:

* A “Performance Standby” supports an obligation to perform other than to pay money, including for the purpose of covering losses arising from a default of the applicant in completion of the underlying transactions.

* An “Advance Payment Standby” supports an obligation to account for an advance payment made by the beneficiary to the applicant.

* A “Bid Bond/Tender Bond Standby” supports an obligation of the applicant to execute a contract if the applicant is awarded a bid.

* A “Counter Standby” supports the issuance of a separate standby or other undertaking by the beneficiary of the counter standby.

* A “Financial Standby” supports an obligation to pay money, including any instrument evidencing an obligation to repay borrowed money.

* A “Direct Pay” Standby supports payment when due of an underlying payment obligation typically in connection with a financial standby without regard to a default.

* An “Insurance Standby” supports an insurance or reinsurance obligation of the applicant.

* A “Commercial Standby” supports the obligations of an applicant to pay for goods or services in the event of non-payment by other methods.

Uses of standby letters of credit.

A standby letter of credit helps facilitate international trade between companies that don’t know each other and have different laws and regulations. Although the buyer is certain to receive the goods and the seller certain to receive payment, a SLOC doesn’t guarantee the buyer will be happy with the goods.

The role of a standby letter of credit is that the issuer will “stand by” to perform in the event of the account party’s non-performance or default.

What is the importance of a standby letter of credit?

A Standby Letter of credit is most often used by a business to help it obtain a contract. The contract is a “standby” agreement between the two companies because the bank will have to pay only in a worst-case if the buyer fails to pay. Although a Standby letter of credit is a guarantee from the bank for payment to a seller, the standby letter of credit must be followed exactly.

The standby letters of credit are most commonly used by the buyers to ensure sellers about their creditworthiness and their ability to pay by guaranteeing payment. Just as the bank guarantee works, the standby letter of credit also works without the bank having to commit any of its assets during the transaction. The bank, however, is liable for payment on presenting the supporting documents.

Why use a letter of credit?

A Letter of credit is highly customizable and enables new trade relationships by reducing credit risk, but it can add to the cost of doing business in the form of bank fees and formalities.

Uses A Letter of Credit

1. Safely expand the business internationally.

2. Highly customizable.

3. Seller Receives money on fulfilling terms.

4. Works like a credit certificate or buyers.

5. Seller is free of credit risk.

6. Quick to execute for credit risk.

7. Quick to execute for creditworthy parties.

8. Payment assured indisputable transactions.

9. Timely payment leads to better cash flow planning.

10. Pre-shipment financing available to sellers.

How can you apply for a Standby Letter of Credit?

There are many aspects that a bank will take into consideration when applying for a Standby Letter of Credit, however, the main part will be whether the amount that is being guaranteed can be repaid. Essentially, it is an insurance mechanism to the company that is being contracted with.

As it is insurance, there may be collateral that is needed in order to protect the bank in a default scenario — this may be with cash or assets such as property. The level of collateral required by the bank and by the size of the SBLC will largely depend on the risk involved, and the strength of the business.

What are the fees for Standby Letters of Credit?

What are the fees for Standby Letters of Credit? It is standard for a fee to be between 1–10% of the SBLC value. In the event that the business meets the contractual obligations prior to the due date, it is possible for an SBLC to be ended with no further charges.

What is the difference between SBLCs and LCs?

While LC is used as a primary method of payment, SBLC is used when there is buyer’s non-performance during the sale. … On the other hand, bank also does not pay supplier until confirmation is received that goods have been shipped, thereby safeguarding the buyer’s interest.

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