Stand-by Letter of Credit

According to the site Credit Management World, a stand-by letter of credit is a written obligation from a bank to pay a sum of money to a beneficiary on behalf of the bank's customer in the event that the customer does not pay.

A Commercial Letter of Credit is taken as Guarantee to be used in payment of goods and services. The Standby Letter of Credit issued is taken as guarantee that the applicant, the customer of issuing bank will execute responsibilities under an agreement. In other words, if an applicant fails to meet the promises made, the beneficiary draws on standby. According to the Controller of Currency, Standbys defined as, ‘any letter of credit or a similar document issued which mentions responsibilities to the beneficiary on the side of issuer.

The SBLC (Standby Letter of Credit) mentions details regarding-

1. To pay back the money borrowed or advanced to or for the account of the account party.
2. To pay on account of an indebtedness undertaken by the account party.
3. To pay in case of default by the account party in meeting of any promises made.

In the first condition, the bank which issues the SBLC agrees to pay back the money advanced or borrowed in case if applicant fails to pay. For example, a U.S. bank which offer finance to local unit of a foreign business may require SBLC payable to the bank from the foreign unit’s bank to bear the loan. In case, if local business fails to repay the loan, the U.S. bank rely on the standby to recover the unpaid loan amount.

The SBLC may also be used to guarantee the payment of invoices for sales made on open account. The purchasing party may request his bank to provide SBLC to the seller with the criterion that the Standby may be drawn on in case if outstanding bills amount are not paid within the asked time duration. If the purchasing party fails to pay on time and original invoice is unpaid, the seller has the complete authority to draw on the standby by presenting a draft, copies of the due invoices and letter with clear mention that invoices are due.

Another popular use of SBLC is to use as performance bonds or bids. The business which bid on contract to offer goods and services may be required to supply a bond or SBLC which may be drawn if business fails to fulfill the bid awards. Standby Letter of Credits are also taken is use to guarantee performance under contractual deals. For example, a builder may produce SBLC to guarantee fulfillment with government regulations and building codes. Such types of standby are termed as performance bond and may be used to make sure on time delivery of goods and services.Both performance bond and bid standbys are payable when presented along with a request letter with mention that the applicant or buyer has failed to keep promises or make payment on time.

Bank Guarantee

A stand-by letter of credit can help facilitate a transaction by providing comfort to the beneficiary. The stand-by letter acts as a guarantee from the bank that the beneficiary will be paid for his goods or services.

A Solid Agreement

The stand-by letter obligates the bank to make payment, even if there are disputes between the customer and the beneficiary.

Collateral

The customer applying for the stand-by letter of credit must have a credit line or collateral equal to the value of the letter. The assets are frozen by the bank until the transaction is completed.

Popular in America

The stand-by letter of credit is used primarily in the United States and is often called a non-performing letter of credit, because it serves only as a backup should the buyer fail to pay as agreed.

Typical Uses

Stand-by letters of credit are used to guarantee repayment of loans, to ensure fulfillment of a contract, and to secure payment for goods delivered by third parties.

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