Standby LC is a type of letter of credit where the issuing bank guarantees an on-time payment to the seller if the applicant/buyer is unable to make the payment provided that the seller meets all the mentioned terms & conditions in the SBLC contract. It is also known as SBLC and acts as a safety net for the sellers to ensure a complete payment for the delivered goods & services to the buyer.
The Standby letter of credit service is widely used in international trade transactions where the parties-to-the-contract are unfamiliar with each other and willing to eliminate the associated overseas risks. Some of these risks include bankruptcy and improper cash flows on the part of the buyer which leads to a delay in the payment to the seller. In case of an adverse event, the bank issues a guarantee to make the remaining payment to the seller as long as they meet the requirements of SBLC.
While issuing an SBLC in the favor of the seller, the buyer’s bank verifies the credit quality of the buyer and once it gets satisfied, the bank notifies the seller’s bank assuring its commitment to pay the seller if the buyer defaults on the agreement. In short, it is proof of the buyer's credibility to make the payment.
There are mainly two types of Standby LC. Here they are as follows:
1. Financial SBLC - In a financial Standby letter of credit, the issuing bank guarantees payment to the seller for the delivered goods or services by an agreement. It is an irrevocable undertaking by the bank where the bank promises to fulfill the financial contractual obligations mentioned in an agreement. Before issuing the SBLC, the bank evaluates the creditworthiness of the buyer
2. Performance SBLC - It is a less common type of trade finance where the bank guarantees that the buyer will complete the assigned projects on-time mentioned in the contract. In the event, if the buyer is not capable of doing so, the bank is responsible to reimburse the seller. In short, a performance SBLC ensures the on-time completion of a project within the scheduled time limit. If the bank’s client is unable to complete the project, the bank promises to reimburse the beneficiary.
1. Advance Payment SBLC - This type of SBLC is issued to provide security against one party’s failure to pay the advance payment of another party.
2. Bid bond/ Tender SBLC - It provides security to the seller against the buyer’s failure to complete the project once the applicant has been assigned the bid or the tender for it.
3. Counter SBLC - This standby LC is also known as a backstop or a protective standby LC issued by a bank in one country to a bank in another country with a request to issue a new SBLC to their local beneficiary.
4. Direct Pay SBLC - This standby LC provides security in the event of financial incapability of the applicant. It is irrevocable.
5. Insurance SBLC - This type of SBLC provides support to the beneficiary in case the applicant has committed for insurance but defaults to do so.
6. Lease Support SBLC - This is issued in case of tenant and landlord relationship. The bank generally demands collateral.
As the name suggests, in a Standby LC, the issuing bank stays in “standby mode” and only interferes when the buyer defaults as long as the terms & conditions of the contract have been fulfilled by the seller. We can understand the working of SBLC from this example.
Let’s assume an importer makes a deal with an exporter to ship 10,000 printers on open credit. The exporter wants to save his organization against the importer’s default of paying on-time and demands for issuing an SBLC as a part of their agreement. The importer applies for a standby LC and due to the good credit rating of the applicant, the bank issues the letter and sends it to the seller’s bank. Now, if the buyer is unable to make the payment, the seller can show the proof to the issuing bank and get reimbursed. This is how a standby LC works but how can an individual apply for it? Keep reading:
The process of applying for an SBLC is quite similar to applying for a commercial loan but with a few differences. Here is a step-by-step guide which an individual is required to follow while applying for a standby letter of credit. Let’s have a look:
1. The buyer can visit the branch of the bank or a financial institution and apply for an SBLC.
2. The bank verifies the creditworthiness of the buyer and checks whether an SBLC should be issued or not. The bank may ask for the financial history of the applicant along with their credit reports and ratings.
3. If the bank is suspicious about the buyer’s ability to pay, it may ask for additional collateral to be provided.
4. Once the buyer establishes its sufficient creditworthiness to the bank, the bank can ask for the details of an agreement between the buyer and seller including information such as seller’s name & address, company details and shipping documents, etc.
5. When the bank is satisfied with the provided information, it provides an SBLC to the buyer for which the bank charges a certain part of the SBLC as a yearly fee.
6. When the buyer pays the seller for the delivered goods & services, the bank terminates the SBLC without any charges.
7. If the buyer is not capable of paying, the seller can approach its bank and demand the payment.
An SLC ensures the seller that the payment will be done on-time in case if the buyer defaults. It provides credibility to an international transaction. Apart from these benefits, it provides some other benefits also. Let’s have a look:
1. A Proof Of Buyer’s Creditworthiness - When a legal and reputed bank or financial institution issues its applicant a standby letter of credit, it acts as a legal statement about the ability of the buyer to pay to the seller. It assures sellers that in any adverse event, they will be paid for the delivered goods & services.
2. Builds Trust Between Parties - Most of the international trade deals do not get success due to the lack of trust and associated overseas risks of non-payment or non-fulfillment of the terms & conditions of the contract. Issuance of a standby letter of credit is the best way to mitigate the gap and ensure parties about the safety and reliability of the transaction.
3. Helps In Business Expansion - Most global traders dealing in international trade are often afraid about the reliability and genuineness of the parties-to-the-contract. It ultimately prevents them from expanding and developing their business in the global market. An issuance of standby LC can mitigate all these struggles by enabling parties to reach new customers.
4. Customization is Possible - Another benefit of acquiring a standby letter of credit service is that it can be customized following the comfort and convenience of the parties. Both the parties can put forth their terms & conditions into the contract.
Standby letters of credit are completely safe, reliable, and highly secure documents that ensure the on-time payment for the goods in case the buyer defaults or is incapable of paying as per the contract.