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. A few of the most common documents are packing and invoice lists, shipping docs like the 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 the presentation of the supporting 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 a standby letter of credit
A standby letter of credit can even be used to finance bigger purchases of facilities or machinery. 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 the 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 with 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 letters of credit.
There are 3 types of standby letters 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 up to years.