Standby Letter Of Credit (SBLC): Definition, Type & Process
What Is A Standby Letter of Credit?
A standby LC is a legal document issued by the bank or any other financial institution on the request of the importer where the bank guarantees an on-time payment to the exporter in the event if the importer defaults on the agreement provided that the exporter fulfills the terms & conditions of the contract. A standby LOC provides a safety net in international transactions and ensures on-time payment to the exporter for delivering complete service or a shipment of physical goods. It is issued by the banks where the two parties to the contract don’t know each other and the agreement involves risks of international trade such as distance or different laws and regulations etc.
- The bank providing Standby letters of credit services should be a neutral third party.
- The buyer is assured to get goods & services and the seller is assured of getting payment but standby LC does not provide a guarantee regarding the quality of the goods.
- The bank promises to make the full or remaining payment to the seller as long as they meet the requirements of SBLC.
- Any bank or financial institution can issue a standby LC to the importers once they get satisfied with the credibility of the applicant.
- It is one of the most frequently used trade finance instruments in international trade transactions.
How Can An Importer/Buyer Obtain A Standby Letter Of Credit?
The process of getting SBLC services starts with the buyer's approach to his bank or financial institution and the establishment of their creditworthiness. The bank may demand additional collateral in case if the risk or the amount is huge. Once the buyer fulfills the terms & conditions and the bank deems it fit for lending, the bank issues them a standby LC and charges 1% to 10% of the total amount as annual fees.
Parties Involved In Standby Letters Of Credit Process
1. The applicant - The person who applies for the letter of credit.
2. The Issuing Bank - Applicant/buyer’s bank that issues the standby LC.
3. The Beneficiary - Also known as exporter or seller in whose favor the letter of credit is issued.
4. Confirming Bank - The bank that adds its confirmation to the credit upon the issuing bank’s request.
5. Advising Bank - It is the bank that may accept and collect the letter of credit on behalf of the beneficiary.
Types of Standby Letters of Credit
There are mainly two types of SBLCs. Here they are as follows:
Financial SBLC - By issuing a financial standby letter of credit, the respective bank or financial institution promises to pay the seller for the delivered goods or services as per the agreement within the prescribed period. For example, an exporter delivers goods to a foreign buyer with a promise of getting payment within 60 days. In case if the payment has not arrived, the exporter can collect payment from the buyer’s bank as per the terms of SBLC.
Performance SBLC - On the contrary, in a performance standby LOC, the bank provides a guarantee of completion of a particular project as per the agreement. It is a less commonly used type of trade finance giving assurance of completed projects within the scheduled time. If a bank's client defaults, it will be reimbursed by the bank. For example, An IT company hires a contractor to build his new office. If the contractor fails, the issuing bank will pay the entire or remaining amount.
Advance Payment SBLC - If one party of the contract fails to pay the advance amount, it provides security to the other associated party.
Bid Bond/Tender Bond Standby - It provides security against a party’s failure to complete a project if the party has been awarded the bid or the tender.
Counter Standby -It is also known as a backstop or a protective SBLOC issued by a letter of credit service provider in one country to a bank in another country, requesting them to issue a new standby payment guarantee letter to the local beneficiary.
Direct Pay - It is issued in the event of financial incapability of the applicant.
Insurance Standby LC - If the applicant has approached for the insurance but fails, it secures the beneficiary.
Recommended Read: Letter of Credit Guide - Features, Importance, Process & When To Use It
How Does A Standby Letter Of Credit Work?
Standby letters of credit are one of the most trusted and popular types of trade finance that provides security to the worldwide exporters against the non-payment or non-fulfillment of the terms & conditions of the SBLC contract/agreement. But how to apply for it? The process of applying is quite similar to applying for a commercial loan but in this case, the bank may ask for collateral to serve as a security in the event of the applicant's default.
Here is the step-by-step guide to getting a standby letter of credit services. Let’s have a look:
- The buyer can request his/her bank or financial institution to issue a standby letter of credit in the favor of the exporter.
- The letters of credit service provider then verifies the credibility & authenticity of the buyer’s creditworthiness to decide whether to lend the finance or not. The buyers may be asked to provide credit history and CIBIL ratings.
- If the bank is in even a slight doubt about the reliability of the applicant or suspects his capability to pay the loan, the bank may not grant him an SBLC.
- In case if there is a big valued transaction involved, the bank may ask for providing collateral. The size of the collateral depends on the involved risks.
- The additional required information includes the seller’s name & address, company details, the period for which the LC is to be taken as well as shipping documents, etc.
- Once the bank is satisfied with the buyer’s credibility, and documents, it issues a standby letter of credit to the importer.
- If the buyer meets all the terms & conditions of the LC agreement ie. pays the exporter before the due date for the goods & services, the bank will terminate the SBLC without imposing a single charge to the buyer.
Pro Tip - The importers & exporters dealing in international trade & transactions need to keep one thing in mind that a Standby letter of credit is not meant to be used for secured execution of transactions, rather they come into action when one of the parties defaults and the beneficiary submits the proof of the same.
Why Should We Use Standby LC In International Trade & Transactions?
The Standby LC is often used in international trade & transactions involving a large requirement of money and associated risks. A standby LOC provides several benefits in executing an international trade transaction. Some of the major benefits are here as follows:
Safe Business Expansion Globally - The first and foremost benefit of issuing Standby LC is that it establishes trustworthy relationships between the parties-to-the-contract initiating an overseas deal and do not know each other, have not personally met or in case of newly established trade relationships. A standby LC promotes safe and reliable business expansion on a global level.
It Is Highly Customizable - Another benefit of issuing standby LC is that both the parties to the contract ie. importers and exporters can put their terms & conditions in the agreement after giving mutual consent. It can also be customized from one transaction to another with the same transaction partner.
Seller Is Assured Of Payment - A standby payment guarantee letter ensures exporters that they will be paid on-time by the importers because in case if importers fail to do so, the exporter can show the evidential documents to the issuing bank. Then, the bank checks the documents submitted by the beneficiary to see whether they satisfy the terms and conditions of the contract specified in the LC and pays the full amount.
Proof of Creditworthiness For Buyer - A standby LC serves as legal proof of creditworthiness for the buyer and ensures the seller that the buyer is financially stable and in a condition to pay your amount. With this, the importer can execute multiple transactions at the same time as he is secured by a legal institution.
Seller Is Free From Credit Risk - A letter of credit is a safer and more financial tool for the sellers in the international market in case the buyer or importer gets bankrupt. As the creditworthiness of the buyer is shifted to the issuing bank, the exporter can recover his amount from the bank as agreed in the standby LOC. Thus, a standby payment guarantee letter frees the exporter from the payment and credit risk.
If you are an international businessman and looking for a safe platform to apply for a letter of credit service, Emerio Banque is the one-stop solution. We are offering international trade finance, investment, and offshore banking services to business corporations.
FAQs on Standby LC
1. Are Standby LCs safe?
Since they are issued by a bank or recognized financial institution after conducting a thorough check on buyer’s credibility, they are highly secure trade finance instruments. It guarantees an on-time payment to the seller in case the buyer defaults.
2. How to use SBLCs?
The buyer can visit their bank’s branch and request the issuance of a standby letter of credit. If the bank is satisfied, it can issue it in the favor of the exporter.
3. Can I get a confirmed SBLC?
Yes. They can be confirmed like a regular letter of credit.
4. How can I cancel SBLC?
Standby LC is an irrevocable document and thereby it cannot be revoked or canceled without the prior consent of involved parties.
5. Are transferable standby LCs available?
Yes. A transferable standby LOC can be issued by the banks where the original beneficiary can sell or assign their rights to another/second beneficiary.
6. What is the difference between SBLCs and LCs?
An SBLC is paid when there is a default made by the importer while an LC is the guarantee of payment after fulfillment of certain terms & conditions.