Difference Between Standby LC And Letter Of Credit

May 04, 2021 - 11:53 AMAuthor - Kenneth

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Both letter of credit and Standby letters of credit are the most popular and commonly used trade finance instruments in the international market. Both of them ensure an on-time payment to exporters/sellers against the non-payment & non-fulfillment on the hands of buyer/importer. But there are some basic differences between these two instruments. Let’s start by understanding their meaning.

What Is A Letter Of Credit?


A letter of credit or a documentary credit is a legal document issued from the bank to the exporter on behalf of the importer/applicant where it promises that the importer will fulfill his contractual obligations and pay the exporters on-time. In the event, if the buyer defaults, the full or remaining amount will be reimbursed by the issuing bank. In short, the issuing bank ensures that the buyers pay on-time.

What Is A Standby Letter Of Credit?


On the other hand, a Standby LC is a secondary payment method where the bank promises that the exporter will be paid on-time in the event if the buyer defaults and unable to pay as long as the exporter submits the proof that all the terms & conditions have been met by him. It provides additional safety to the sellers. There can be multiple reasons behind the buyer’s default such as cash flow inadequacy, or bankruptcy, etc. But only comes into action when the seller meets the requirements of the Standby LC agreement.

Standby LC V/s Letter of Credit


Both Standby LCs and payment guarantee letters are backed by a legal institution like a bank or a public financial institution on the request of the buyer to ensure their suppliers on-time & full-fledged payment while executing international trade deals. If you also want to apply for the letters of credit and are looking for Letter of credit service providers, here are some key differences which you need to keep in mind. Let’s have a look:

1. Addition of Special Features - Unlike a standby letter of credit, a payment guarantee letter does not contain a set of special features or requirements imposed by the buyer for the seller to be completed while executing the deal. On the contrary, in case of issuance of a standby payment guarantee letter, the buyer is allowed to impose some specific clauses to the agreement which a seller needs to fulfill. It can be about the number of goods or packaging requirements etc.


2. Requirements by Issuing Bank - The LC service provider ie. the bank verifies the buyer’s credibility and credit score regarding the capability of paying the loan amount before issuing a documentary credit letter. Furthermore, it is the buyer who usually asks for an LC in exchange for which the bank charges a certain fee or cost for its services. As such, the buyer may be unwilling to pay which leads to insecurity in LCs. On the other hand, a Standby LC imposes an obligation on the bank and therefore it asks for collateral in the form of security to issue an SBLC.
 
3. Purpose of Issue - The ultimate goal of issuing a payment guarantee letter is to ensure that the transaction goes as planned throughout the process, so it is a primary instrument of payment. It is the standard payment document used in international trade to assure as well as to secure the seller that the buyer will fulfill his promises. While, on the contrary, an SBLC is a secondary instrument of payment as the word suggests itself.

4. Duration - A letter of credit is a short-term instrument that usually expires within 90 days while a Standby documentary credit letter is a long-term instrument with the validity of one year.

5. Area of Use - A letter of credit is the most frequently used trade finance instrument in a sale agreement while an SBLC is generally used to provide security in long-term construction projects. In addition to this, SBLCs are also used in domestic transactions.

6. Issuing Cost - The cost of issuing a Standby LC is more than a regular LC. The charges for issuing a regular SBLC range from 1% to 10% of the amount covered while in the case of LC, it ranges from 0.75% to 1.50% of the amount covered.

Both SBLC and LC are the extensively used trade finance instruments in the international market as well as domestic trade transactions. Both are issued by the bank at the request of the buyer or importer in the favor of the exporter to assure the payment for the delivered goods & services.

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