Standby Letter of Credit

What is a Stand by Letter of Credit or SBLC?

Let us understand all about SBLC through a series of questions and answers.

What does SBLC mean?

The standby letter of credit (SBLC) is a type of letter of credit (LC) in which the issuing bank agrees to pay the beneficiary if the applicant does not make the payment.

What is SBLC used for?

SBLCs are a type of contingency plan. For other LCs, the bank makes the payment first, and then the applicant pays the bank at a later date. However, when a bank issues an SBLC, it is only obligated to make the payment if the buyer or applicant defaults.

Who can issue SBCLs?

Any bank or NBFC can issue an SBLC once they are sure of the creditworthiness of the applicant. This is because the issuing banks or institutions are exposed to the greatest risk in the process.

How to get SBLC?

To obtain a standby letter of credit, the buyer must contact a bank and establish their creditworthiness. The bank may request additional guarantees if the risk or amount is too high. Once the buyer meets all conditions and is deemed eligible for credit by the bank, the bank issues an SBLC and charges 1% to 10% of the total amount as an annual fee while the standby letter of credit is valid. valid. .

Types of SBLCs

1) Financial Reserve Letter of Credit

A financial SBLC guarantees payment to the seller or service provider for the goods or services provided under the agreement within the stipulated period.

Example: If a food color manufacturer sends a shipment to a soft drink company against a financial SBLC and the company is unable to pay, the issuing bank will step in and pay the manufacturer for the color. Subsequently, the soft drink company would have to pay the full amount and interest to the issuing bank.

2) Letter of credit pending performance

A performance SBLC is used less frequently compared to a financial SBLC. Performance SBLCs provide a guarantee of completion of a project as per the agreement or contract. If the

service provider does not complete the project within a stipulated time frame, the bank steps in and reimburses the client.

Example: An IT company hires a contractor to build a new office. The contractor agrees to complete the construction within a specified time frame, but fails to deliver. However, if this agreement is protected by a performance SBLC, the issuing bank will pay all project fees to the IT company and collect penalties from the contractor. This acts as a security check to ensure high budget projects are completed in a timely manner.

3) Advance payment SBLC

Advance Payment Standby LC provides security against failure of one party to pay the other party’s advance payment.

4) Bid Bond/SBLC Tender

Bid Bond/Pending Bid LCs act as a security against non-completion of the project once the applicant has been awarded the bid or bid for the project.

5) SBLC Counter

Also known as a backstop or protective standby, Counter SBLC is a type of LC issued by a bank in one country to a bank in another country, her the bank ask the other bank to issue a new SBLC to the benificiary located in that country.

6) Direct Pay SBLC

Direct payment SBLCs act as collateral in the event of financial instability of the applicant. A direct payment reservation is irrevocable.

7) SBLC Insurance

SBLC provides support to the beneficiary in the event that the applicant has engaged in insurance or reinsurance but fails to do so.

8) Support SBLC lease

The bank that represents the tenant before the landlord issues a lease support SBLC. The bank usually takes a deposit as collateral for the SBLC. You agree to pay the rent to the landlord in the event that the tenant is unable to do so.

HOW DOES AN SBLC WORK?

Here is a step by step process of how an SBLC works:

The process for obtaining an SBLC is quite simple and similar to obtaining any other type of LC or a loan from a bank. A buyer simply walks into a bank or financial institution and applies for an SBLC.
The bank then begins to investigate the applicant’s creditworthiness and decides whether or not the person should be credited with the SBLC. The bank reviews the applicant’s financial history, as well as their credit reports and scores.
If the bank suspects that the buyer will not be able to comply with the LC, it can request that an additional guarantee be provided.
The collateral amount depends on the risks involved and the the nature of the business.
Once the buyer establishes sufficient creditworthiness, the bank requests the details of the agreement between the buyer and the seller. Information such as the seller’s name and address, company details, the time period for which the SBLC will be taken, as well as shipping documents, etc., are sent to the bank.
Once the bank is satisfied with all the information at its disposal and its background checks have returned satisfactory results, it provides an SBLC to the buyer. The bank charges 1% to 10% of the SBLC amount as an annual fee, and it is applicable until the SBLC is valid.
If the buyer fulfills his obligations in the contract before the expiration date, the bank will terminate the SBLC at no additional charge to the buyer. Once the buyer pays the seller for the goods or services, the bank cancels the SBLC and does not charge the seller beyond that point.
As discussed above, SBLC is not actually intended to be used and only acts as a security against default. It is useful if the buyer cannot fulfill the agreement with the seller, the seller goes to the bank and presents the proofs as mentioned in the SBLC. Once the bank verifies the evidence, it releases the payment to the seller. After that the importer/buyer makes the payment to the bank at a later date along with interest.

ADVANTAGES OF SBLC

SBLC Bridges Lack of Trust between the parties involved
Lack of trust and fear of default is one of the main reasons why some international trade deals fail. An SBLC is the best way to bridge the gap and ensure all worst case scenarios are addressed.
Serves as a great proof of solvency
Once a reputable financial institution lends someone a standby letter of credit, they are practically making a statement about their financial situation and that of their company. This goes a long way in establishing solvency.
Can help with business acquisition
Startups may not get big projects because they don’t have a legacy to back them up. Companies often cringe when working with such people or companies. However, with an SBLC, they have strong backing from a reputable financial institution and thus can successfully compete for prestigious contracts and high-value projects.

SBLC AND BANK GUARANTEE, WHAT ARE THE DIFFERENCES?

The fundamental difference between a letter of credit and a standby letter of credit is that the former can be charged or discounted during a commercial transaction. While an SBLC is only a security measure and is only charged if either party defaults on the agreement, an SBLC discount cannot be obtained if there is no default. Most of the trades are honored by all parties without any irregularities and thus the SBLC is broken once the trade takes place.
On the other hand, while a bank guarantee only protects the buyer against a defaulting seller, SBLCs protect both the buyer and the seller, depending on the type of SBLC issued.

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