A standby letter of credit – What is it and how is it used in international trade?
If you’re into international trading, you must have come across a standby letter of credit which is a financial instrument that is utilized mainly in domestic and international trade or other construction projects. The standby letter of credit is usually given by a bank and the bank gives a guarantee of making payments to the seller or the beneficiary if the buyer is not able to pay in terms of the contract and provided all the necessary documents are shown.
The standby letters of credit are most commonly used by the buyers to ensure sellers about their creditworthiness and their ability to pay by guaranteeing payment. Just as the bank guarantee works, the standby letter of credit also works without the bank having to commit any of its assets during the transaction. The bank however is liable for payment on presenting the supporting documents.
The standby letter of credit – How does it work?
The buyer has to apply for a standby letter of credit at any commercial bank and he has to show either the credit substantiation or the collateral to justify issuance of the standby letter of credit and then pay the fees charged by the bank. As a part and parcel of this process, the buyer offers information on the beneficiary, the shipping documents that are required for payment, the information on that bank that is working on behalf of the beneficiary and the stipulated time period through which the standby letter of credit is valid. In an event where the buyer is not able to pay off the seller, the seller presents all the aforementioned documents listed on the LC within the specific time period. Later the issuing bank pays off the due amount to the advising bank.
Standby letter of credit supporting documents for international trade
The standby letter of credit pays in case the buyer falls back on the payments only when the supporting documents are shown. The documents that are required are just a matter of arbitration and it may include anything that has been agreed by the seller and the buyer. Few of the most common documents are packing and invoice list, shipping docs like bill of lading, insurance certificates and transport documents. There are other official documents too like inspections certificates ad certificates for custom clearance. Hence, you can well understand that it is a never-ending list of supporting documents.
Standby letter of credit – What are the requirements?
Just as the normal letters of credit, the standby letters of credit are associated with different requirements besides the fact that the buyer pays on presentation of the supported documents. The buyer also has to consult with a shipping (international) specialist on the ‘requirement’ language to include into the standby letter of credit to make sure that all the interests of the buyer are protected and safeguarded.
Letters of Credit and Standby letter of credit – What are the differences?
The LOC is a method of paying for your goods and the standby letter of credit is a performance guarantee that will ensure that the payment for the goods will be definitely paid in case the buyer defaults. Since it offers a guarantee of payment, the main advantage of a standby letter of credit is that it involves less hassle and cost as compared with other forms of guarantees. Nevertheless, it can’t be denied that a standby letter of credit is a rather new instrument that doesn’t have too much of history associated with it.
Funding bigger purchases like real estate with standby letter of credit
A standby letter of credit can even be used to finance bigger purchases of facilities or machineries. Do you have a bad credit rating? If answered a standby letter of credit could improve your rating and automatically lower the interest rate on the loans. As the bank is guaranteeing the payments, the risk is much lower on loans.
This is especially useful for a contractor who predicts buying a house, renovating it and selling it to a buyer within 60-90 days. There are few standby letters of credit that have longer terms and hence such transactions are easier.
Therefore, if you wish to expand your business and also enhance your risk profile, you should seek help of a standby letter of credit to reap the above listed benefits.
Advantages of using Standby Letter of credit:-
1.The seller can still be accounted to be paid in case he is not able to present the conforming documents.
2. The process is easier than any other documentary letter of credit.
3. The seller doesn’t bear any burden of proof whether the goods were actually delivered or not.
Pre-requisites for obtaining the standby letter of credit-
1. One must have appropriate evidences to show that he has the ability to pay the loan.
2. Something must be presented to the bank as a collateral which will act as a security in case you are unable to pay.
3. Once the bank is completely satisfied of your ability to pay the loan, after inspecting the documents presented by you, the bank will provide you in writing within a week’s time.
4. A fee needs to be paid for every year the Standby letter of credit remains in effect.
5. A fee of about 1-10% of the total monetary value of the letter of credit has to be paid.
Types of standby letter of credit.
There are 3 types of standby letter of credit.
1. Financial SBLC
2. Performance SBLC
3. Revolving SBLC
1. Financial SBLC
This is an irrevocable assurance made by the issuing bank to the seller in case the buyer fails to make the payment.
2. Performance SBLC
This is an undertaking by the bank in the circumstance that the buyer has failed to make the payment. The bank promises to pay 50% of the value of the transaction when the buyer fails to make the payment.
3. Revolving SBLC
It is issued by the bank to enable long-term business between an importer and an exporter and is used to cover multiple shipment contracts which may validate upto years.
Usance Letter of Credit – What you should know on it
Usance letter of credit has been given different names like Time LC, deferred letter of credit or Term LC. As you open a usance LC or a deferred LC, it means that the payment will be done after a pre-set time on a future date on confirming the documents. A usance letter of credit is just the opposite of Sight letter of credit. In case of a sight letter of credit, the payments are made to the seller only when the seller confirms the documents which are presented to the issuing bank.
On the contrary, the payments of Usance LC are done on the receipt of documents that are issued by the issuing bank and it is also checked whether or not the documents abide by the predetermined terms and conditions that are mentioned in the original LC. The bank accepts the draft and pays on the maturity date according to the LC terms.
Understanding usance letters of credit
A deferred letter of credit or a usance letter of credit is a typical term that is used in trade finance. But before you move on to understand usance letter of credit, you should first understand what a letter of credit is and why it is used. As long as international trade is concerned, there is enough lack of trust in such transactions and hence the mechanisms like letters of credit are utilized to reduce the risk. Letters of credit have different types like usance LC, site LCs and Standby LC.
Letters of credit are utilised to facilitate trade between the sellers and buyers of goods all over the world. For aggravating trade, the letters of credit are kept at the right place by the seller and buyer. When the bank issues such LCs, it allows both the parties to trade in peace. Only after certain conditions are fulfilled, goods can be released and it is thereafter that the payment can be made by the purchasing bank. While taking a look at the various kinds of instruments, the factor of when a payment is done is of highest importance.
Advantages of usance letter of credit for the seller
The seller gets the obligation of the bank of the buyer to pay for the shipped goods
Reduces the risk of production if the buyer changes or cancels his order
The seller can know the exact date of payment for the goods
The opportunity to receive financing during the period between shipment of goods and receiving the payment
The buyer can’t refuse to pay due to any unnecessary complaints about the goods
Advantages of usance letter of credit for the buyer
The bank will pay off the seller for the goods and services provided the latter shows the determined documents associated with the letter of credit
The buyer demonstrates his solvency through a letter of credit
The buyer controls the time period that is required for shipping of goods
For issuing a usance letter of credit for delayed payment, the seller grants credit to the buyer
Having a letter of credit lets the buyer to avert or reduce pre-payment
Usance letter of credit – How is it different?
Another name of usance letter of credit is deferred letter of credit or term LC. As the name suggests, a letter of credit is payable at a future provided the conditions in the letters of credit are fulfilled and all the documents are presented.
If you have to understand usance letter of credit, you can compare it to Sight letter of credit where the funds are instantly transferred to the supplier as soon as the documents are given. In cases where usance LC is used, you’ll find a receipt of the documents by the issuing bank and where these abide by the terms of the LC, the issuing bank receives the draft and transmits funds for payments agreeing upon a future maturity date. The buyer is offered a form of credit terms as the buying party will take the documents of the product bought and also enjoy the ability to pay at a future date.
Usance letters of credit – Know the types
Letters of credit are instruments of payment that are leveraged for improving transactions of international trade. The main purpose of letters of credit is that it mitigates the risk that is linked with international trade for the seller and the buyer. As with any other financial mechanism, letters of credit even have various secondary purposes. There are multiple types of letters of credit that serve different purposes and one such kind is usance letter of credit.
A usance letter of credit offers deferred option for payment to the buyer and the tenure of payment is decided by the seller and the buyer. Similarly, the usance letter of credit can be categorized in 2 types based on the tenors:
Payment within 90 days post the B/L or the Bill of Lading
Here, after the B/L is issued, the buyer is given a time of 90 days from the date of B/L to pay for the goods.
What is The Bill of Lading?
A bill of Lading is a document between the carrier (transporter) and the shipper of goods, that confirms the receipt of goods to be transported. It contains the details regarding the consignor’s name, consignee’s name, the date when the goods have been loaded, account numbers used to track the orders etc.
Payment within 30 days post sight
In this case, the date on which the issuing bank obtains the documents, from that date, the buyer will be given 30 days or a month to pay for goods.
Usance letter of Credit – Why and when is it used
A usance letter of credit is used for the same reason for which credit terms are offered. The purchaser is allowed more flexibility, increased working capital and the option of selling stock before payment. Goods payment is easier at a later date as against paying on receipt.
The financial instrument called usance letter of credit can be used only when there is a trust element between both the selling and buying parties. You need to have a clear understanding of the amount to be paid and the interest rate of the product. It is through the Letter of Credit that you can set out the actual payment date and time to maturity so that both the parties can take this as a reference.
So, it can be safely concluded by saying that a usance letter of credit is used when the buyer receives an upper hand on the seller and when it is clearly a buyer’s market. This is why the seller agrees to abide by the lenient terms of a usance LC.
Usance Letter of credit – Why is it used?
The same reason for which credit terms are offered, a usance letter of credit is also offered for the same reason. The purchaser is given flexibility, better flow of working capital and availability to sell stocks before payment. In this case, payment for goods is easier when done on a later date as compared to payment on receipt as there would have been an element of payment collection from the actual purchaser.
Usance Letter of credit – When can it be used?
This usance letter of credit can be used only when there is a trust factor between the selling and buying parties. It is vital to understand the future amount that is to be paid and the interest rate that has been decided on the product. The usance letter of credit will set the maturity time and the date of payment so that both the parties can utilize that as a reference. The tenor is set as being specific few days following the BL date. When you have a usance letter of credit, the purchaser deploys funds into different areas of the business till the payment is done.
Thanks to the usance letters of credit that the seller is able to trade in peace as the payment is guaranteed by promises within the banking system.