What is a standby letter of credit?
A standby letter of credit can be considered as a guarantee for payment by the bank on behalf of the importer (client). It is a type of loan within which the bank is responsible for fulfilling the payment obligations at the end of the contract in case if the client is not able to make the desired payments.
It is never meant for the purpose of being used, but it availed for the exception circumstances that may occur due to non payment by the importer. Usually it exists for the purpose of preventing contracts from remaining unfulfilled in case your company closes down, declares bankruptcy, or is due to any reason is unable to pay for consignment provided. Standby letters of credit provides a business’ with credit quality along with repayment abilities.
Types of standby Letter of credit
Generally standby letter of credits are classified in two categories i.e. performance standby LC and financial standby LC.
- Performance SBLC
- Performance standby lc provides surety about the nonfinancial contractual obligations which includes quality of work, work amount being done, time, actual cost and much more. Such LC carries out these tasks in a timely as well as satisfactory manner. If the described obligations are not met by the supplier, the bank is responsible for paying the third party with full amount.
- Financial SBLC
- Financial standby lc provides surety about the financial contractual obligations. Most of the SBLC are financial in nature.
- Financial standby lc are usually required while you are dealing in international trade or may be other large purchase contracts within which payment protections are highly required and can be difficult to obtain.
How to obtain standby letter of credit?
The standby letter of credit process can be very much similar to the process of obtaining a commercial loan, including some few key differences.
Initially you need to provide proof for your creditworthiness. As per the proofs and documents the bank decides that you could be provided with standby letter of credit or not. Well SBLC process is much easier and quicker as compared to other forms. SBLC is generally issued within a week as soon as the required paperwork has been carried out and the documents are submitted.
The bank requires particular standby of letter of credit fee which is specifically between 1-10% of the SBLC amount and is paid before issuing the letter. The fee for standby letter of credit is usually charged on per year basis when the letter of credit is in effect. If the terms described within the contract are fulfilled earlier than the mentioned date, you can easily cancel the SBLC without any additional charges.
Standby letters of credit helps in establishing trust within business partners and act as a powerful tool for accomplishing the business goals.
Examples
Financial standby LC: Supplier, exports goods to a foreign buyer, and the buyer is supposed to pay for the consignment within 60 days. In case the payment does not arrive then seller can ask the buyer to use a standby letter of credit so that the payment can be collected from the importer’s bank. Before issuing the standby letter of credit, the bank has to evaluate the buyer’s credit which helps to determine, if the importer will be able to repay the bank.
Performance standby LC: A contractor has been given with the terms of completing a construction project within the particular timeframe. Let's say the deadline arrived, and the project is not yet completed. In such situations using a standby letter of credit, the contractor’s client can demand for the payment from the contractor’s bank. This payment will function as a penalty for encouraging on-time completion of work. This is a simple example of a “performance” standby letter of credit, where it depicts a situation of failure to performance that triggers the payment.
