What is a Standby Letter of Credit and How Does it Work? (2024)

FAQs

What is a Standby Letter of Credit and How Does it Work? ›

What is a Standby Letter of Credit (SBLC)? A standby letter of credit, abbreviated as SBLC, refers to a legal document where a bank guarantees the payment of a specific amount of money to a seller if the buyer defaults on the agreement.

A Standby Letter of Credit (SBLC / SLOC) is a guarantee that is made by a bank on behalf of a client, which ensures payment will be made even if their client cannot fulfill the payment. It is a payment of last resort from the bank, and ideally, is never meant to be used.

Although an SBLC can provide a high level of security and confidence for the beneficiary, it also carries some risks and limitations. One of the main risks is that the beneficiary might not be able to access the SBLC payment if the issuing bank fails or becomes insolvent.

A Standby Letter of Credit as a Means of Payment

As mentioned above, a SBLC is utilised to underwrite domestic and international trade deals. It is a payment of the last resort and is used when the seller/exporter feels the buyer/importer may have problems paying for goods received.

The Standby Letter of Credit (Standby LC) is, like the guarantee, commonly used to cover the risk of a contract party not fulfilling agreed obligations, for instance failure to pay or deliver.

The primary cost associated with an SBLC is the fee charged by the bank for issuing it. This fee typically ranges from 1% to 10% per year of the SBLC's face value, depending on the bank's assessment of risk. The riskier the client's business proposition or the lower their creditworthiness, the higher the fee.

The client will need to find a lender that is willing to lend money against the SBLC as collateral. The lender may require the client to provide additional information about the SBLC, such as its terms and conditions, the creditworthiness of the bank issuing the SBLC, and the details of the underlying obligation.

An SBLC can act as collateral for a loan when a borrower has limited physical assets to pledge. The SBLC assures lenders of payment from the issuing bank should the borrower default.

Aside from trade credit insurance, there are other alternatives to a letter of credit. Those include: Purchase order financing: Purchase order financing provides you cash up front to complete a purchase order. Under this agreement, a financing company pays your supplier for goods you need to fulfill a purchase order.

We can also issue a Standby Letter of Credit (SBLC) from: HAB Bank, Bank Hapoalim, East West Bank, TD Bank, Bank Leumi, IDB Bank, Hamni Bank, Bank Santander but these banks fees, process and structure are stricter and more difficult.

How do I get my money from SBLC? ›

The two parties are referred to as The Provider and the Beneficiary. Once the Collateral Transfer Agreement is signed the SBLC Provider will instruct their bank to transmit the Standby Letter of Credit. Their bank will SWIFT message the Standby Letter of Credit to the beneficiary's bank for credit to their account.

Beneficiary: The party receiving payment under the SBLC, usually the seller or exporter. Issuer: The bank that issues the SBLC on behalf of the applicant.

In summary, an LC is like a promise from the bank to pay right away if the terms are met, while an SBLC is a safety net, used only if the buyer doesn't pay as promised. Understanding these differences can help you choose the right option for your needs!

1-6-6- Disadvantages of the standby letter of credit

Low protection in the event of default. Time constraints. Utilized for a shorter duration. Less frequently used as the documentary credit, thus it can be prone to errors.

Standby Letter of Credit (LC)

The Importer arranges for their bank to provide the Exporter with a Guarantee that, in the event that goods have been shipped and the Exporter has not been paid, the Importer's bank will guarantee payment for a pre-determined amount.

The importer submits an application for SBLC to a commercial bank or non-banking financial company if they have the provisions to provide SBLC.

Drawing on a standby letter of credit usually requires delivery of a draft and specified documents to the issuing bank in order to receive payment. Such documents usually include submission of the original standby letter of credit and a separate statement. The letter of credit itself will specify drawing requirements.

An LC is used as the main way to make payments, making sure the seller gets paid once they fulfill their part of the deal. An SBLC, on the other hand, acts as a safety net and is used if there's a risk that the buyer might not fulfill their part of the deal.

More often than not, the bank will issue the Standby Letter of Credit (SBLC) within 48 hours of release. Once issued, a copy of the SBLC will be emailed to you as it is transmitted by a MT760 SWIFT message to the beneficiary, including the reference number of the SBLC.

As long as the issuer notifies the beneficiary of their intention to cancel the SBLC within the stated agreed notice period, the SBLC can be cancelled on that expiry without any need to receive consent from the beneficiary.