What is a Standby Letter of Credit?
Many companies ask us what is a Standby Letter of Credit and how it differs from a Bank Guarantee. We will answer the second half of the question first. A standby letter of credit (SBLC) is a means of payment and a bank guarantee is a security for payment, however, a SBLC may be monetised. Under these circumstances the SBLC will become a security for payment.
A standby letter of credit is a bank instrument used for trade finance – a payment of last resort. It represents a contract between a buyer and a seller. The buyer is the provider of the SBLC and the seller is the beneficiary.
How does a SBLC actually work? If the buyer fails to pay the seller for goods received then the seller can claim against the standby letter of credit. The seller instructs their bank to claim on their behalf. Their bank contacts the buyers bank for payment. Under the terms and conditions of the SBLC the buyers bank is legally obliged to pay.
Who Applies for a SBLC?
A seller may feel their buyer lacks a certain creditworthiness. The seller requests the buyer to provide a standby letter of credit in the seller’s favour. The buyer will instruct their bank to issue a SBLC in favour of the seller. Therefore, the buyers bank becomes the issuing bank and the sellers bank becomes the receiving bank.
The buyer will have to fill out standby letter of credit application forms supplied by their bank. There will be essential information required such as due diligence on the buyer and contract details. Other essential information will be amount, currency and expiry date. Once issued and received the seller can forward the goods to the buyer.
The difference between a SBLC, and a Documentary Letter of Credit, (DLC).
We are often asked the difference between a SBLC and a DLC. Under DLC payment terms payment is conditional on the performance of the seller. Under SBLC payment terms payment is conditional on non-performance of the buyer.
Standby letters of credit are a highly popular bank instrument. They are used globally and underpin millions of trade finance contracts. They are often used for monetisation purposes.