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Stand by letter of credit

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.

Key takeaways

  • A SBLC is a type of bank’s commitment about the payment to a third party if in case the bank's client or importer of goods defaults on an agreement.
  • The process of obtaining a SBLC is quite similar to a loan application.
  • The recipient of a standby lc is provides with surety that the business deal being established with an individual/company is highly capable for paying the bill for the goods and services being delivered.

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.

How the process works?

  1. Seller and buyer make a deal. Perhaps, importer wants seller to ship him 10,000 widgets on open credit, or buyer could be a contractor who is promising to build a bridge for seller’s city by next month.
  2. Now the seller wants to protect the organization against buyer, contractor failing to deliver on his promises. As a result, he asks the buyer to obtain a standby letter of credit as part of their agreement.
  3. Buyer asks his bank for a standby letter of credit. Because of his excellent credit and collateral, the bank issues the standby lc.
  4. Buyers bank sends the SBLC to seller’s bank.
  5. Seller reviews the SBLC to make sure it is acceptable, and decides to proceed with the deal.
  6. If in case the buyer fails to meet his obligations, seller can submit documentation to the buyer’s bank as required by a standby letter of credit
  7. Buyer’s bank will pay seller (again, possibly indirectly), and then the buyer will have to pay his bank.

Advantages of standby letter of credit

  • It acts as a secure payment too.
  • Standby letter of credit facilitates exchanges of documents and payments that do not have to be formatted like a documentary credit.
  • It allows the exporter to accept a simple mode of payment just like a bank transfer along with the security of the bank guarantee with the background.
  • Its cost is relatively low as compared to the documentary credit.
  • Bank pays on behalf of the buyer in case he is unable to pay for the consignment being delivered.

LC vs SBLC

LC SBLC
It is termed as ‘Letter of Credit’. It is termed as ‘Stand By Letter of Credit’.
It can be defined as a type of guarantee that the exporter get, to receive payments in time by the buyer. In case of a default, it is defined as an assurance that the supplier will receive correct payments by the bank.
It can be seen as a primary payment mechanism for a payment transaction. It serves as a secondary payment mechanism for a payment transaction.
The expiration date of an LC is usually about one month to three months. The expiration date of an SBLC is about one year and can be more.
It can be considered as an instrument of payment. It is generally used as a backup method to pay the financial credentials of the benefactor.
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FREQUENTLY ASKED QUESTIONS

1. What is the difference between LC and standby LC?

Letter of credit is defined as a type of guarantee that the exporter get, to receive payments in time by the buyer. Whereas, Standby letter of credit is defined as an assurance that the supplier will receive correct payments by the bank.


2. What is LC and SBLC?

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.

An LC is a financial document which is provided by a third party i.e. a bank or a financial institution that guarantees the payment for goods and services to the exporter once the exporter submits the required documents.


3. How much does a standby letter of credit cost?

    Costs are customized for each product transaction and therefore an exact quote can only be provided once a completed application is received, but as per letter of credit pricing guide:

  • A 1 Year Standby Letter of Credit (SBLC) costs 6.8% plus $1,000
  • A 90 Day Standby Letter of Credit (SBLC) costs 3.3% plus $500
  • Additional 30 Day periods cost .6% plus $150

4. What is difference between LC and bank guarantee?

Letter of Credit can be seen as a commitment of importer’s bank to the exporter’s bank. As per LC bank is supposed to accept the invoices being presented by the seller and pay him for the consignment being sent subject to certain conditions. Whereas in Bank guarantee, a surety is given to the beneficiary by the bank on behalf of the applicant, to ensure payment, if in case the applicant defaults to make payment.


5. What is SBLC mt760?

A Standby Letter of Credit (SBLC) can be seen as a payment guarantee which is issued by a financial institution utilizing SWIFT MT760 message, and is specifically used as payment for a customer for the case in which the applicant defaults.