Standby Letter of Credit: A Secondary Payment Strategy

Standby Letter of Credit: A Secondary Payment Strategy

What exactly does SBLC mean?

A letter of credit known as a “Standby Letter of Credit” (SBLC) is one in which the issuing bank agrees to pay the recipient in the event that the applicant is unable to make the required payment.

What purposes serve SBLC?

Contrary to other LC categories, SBLCs are a form of backup plan. Other LCs include the bank making the payment first and the applicant making the payment to the bank subsequently. A bank is only obligated to make the payment when issuing an SBLC if the applicant or buyer defaults.

Who may publish SBCL?

Once they are confident in the applicant’s creditworthiness, any bank or NBFC may offer an SBLC. This is so because the banks or the entities that issue the money are most at risk during the transaction.

How do you obtain SBLC?

A buyer must speak with a bank and prove their creditworthiness in order to receive a standby letter of credit. If the danger or the sum is too great, the bank could request further collateral. When the buyer satisfies all the requirements and the bank approves them for the credit, the bank provides them an SBLC and levies an annual fee of 1% to 10% of the entire amount for the duration that the standby letter of credit is in effect.

SBLC categories

1) Letter of Credit for Financial Standby

A financial SBLC ensures timely payment of the agreed-upon price to the seller or service provider for the products or services delivered in accordance with the contract.

The issuing bank will step in and pay the maker of the dye if, for instance, an edible dye manufacturer sends a shipment to a soft drink company against a financial SBLC and the company is unable to pay for it. The soft drink firm would eventually be required to reimburse the issuing bank for the full amount plus interest.

2) Letter of Credit with Performance Standby

As opposed to a financial SBLC, a performance SBLC is less frequently utilized. Performance SBLCs ensure that a project will be completed in accordance with the terms of the contract or agreement. The bank intervenes and reimburses the client if the service provider is unable to finish the job within the allotted time frame.

Example: To build a new office, an IT business employs a contractor. The contractor promises to finish the project in a certain amount of time but falls short of his promise. The issuing bank will pay the complete project fees to the IT company and will impose penalties on the contractor, though, if this arrangement is covered by a performance SBLC. This serves as a safety check to guarantee that large-budget projects are finished on time.

3) SBLC Advance Payment

Ahead of Time Standby LC offers protection in case one party doesn’t pay the other party’s advance.

4) Tender SBLC/bid bond

Bid security/Tender Once the applicant has won the bid or the tender for the project, the standby LCs serve as insurance against failure to finish it.

5) Counter SBLC

Counter SBLC, often referred to as a backstop or protective standby, is a type of LC sent from a bank in one nation to a bank in another, requesting that they provide a fresh standby LC to their local beneficiary.

6) Direct Pay SBLC

Straight Pay In the event of the applicant’s financial difficulty, SBLCs serve as a security. A direct pay standby cannot be cancelled.

7) SBLC for insurance

If the applicant has committed to purchasing insurance or reinsurance but fails to do so, insurance SBLC offers assistance to the beneficiary.

8) Support for Lease SBLC

The bank acting as the tenant issues a lease support SBLC to the landlord. Typically, the bank accepts a deposit as security for the SBLC. In the event that the renter is unable to pay the rent, it promises to do so on the landlord’s behalf.

How is an SBLC put to use?

This is a step-by-step explanation of how an SBLC operates:

Getting an SBLC is a straightforward process that is similar to getting any other kind of LC or a loan from a bank. A customer can apply for an SBLC by simply walking into a bank or other financial institution.

The bank then begins investigating the applicant’s creditworthiness before deciding whether or not to grant the applicant the SBLC. The applicant’s financial background, credit records, and ratings are all examined by the bank.

The bank may request additional collateral if they have reason to believe that the buyer won’t be able to honor the LC. The amount of the collateral is determined by the risks and the type of business.

The bank requests information about the terms of the buyer and seller’s agreement when the buyer demonstrates sufficient creditworthiness. The seller provides the bank with information such as their name and address, company information, the length of time they want the SBLC, shipping documents, etc.

An SBLC is given to the buyer if the bank is happy with all the data at hand and background checks have shown satisfactory results. The bank levies an annual fee that ranges from 1% to 10% of the SBLC’s value, which is valid for the duration of the SBLC.

The bank will end the SBLC without further charging the buyer if the buyer fulfills its contractual obligations before the due date. The bank cancels the SBLC and stops charging him after the buyer pays the seller for the goods or services.

As was previously said, SBLC simply functions as a security against default and is not truly intended for use. The seller goes to the bank and presents the documentation required by the SBLC if the buyer is unable to uphold the terms of the agreement. The bank releases the money to the vendor after verifying the proofs. The buyer then pays the bank the original balance plus interest at a later time.

What is the price of an SBLC?

Depending on the risks and the amount, banks assess annual fees ranging from 1% to 10% of the total SBLC amount. As long as the SBLC remains active, the fees are valid.

Benefits of SBLC

Lack of Trust in Bridges

One of the main reasons why some international trade agreements fail is a lack of confidence and apprehension about payment default. The only method to close the gap and guarantee that all potential worst-case scenarios are addressed is with an SBLC.

Provides excellent evidence of creditworthiness

When a reputable financial institution extends a standby letter of credit, they are essentially making a statement about the financial health of the borrower and their business. This is very helpful in determining creditworthiness.

Can be used to acquire businesses

Businesses that are just getting started may struggle to secure significant projects because they lack a legacy to rely on. When interacting with such people or companies, firms frequently change their minds. With an SBLC, however, companies have the reliable support of a reputable financial institution and can effectively compete for major contracts and expensive projects.

What distinguishes an LC from an SBLC and a bank guarantee?

The fact that a Letter of Credit can be redeemed or discounted during a trade transaction distinguishes it from a standby Letter of Credit. Although an SBLC is merely a precaution that is only used if one of the parties breaches the contract, it cannot be discounted if there is no default. The SBLC is terminated once the deal is completed because most trades are fulfilled by all parties without any issues.

As opposed to a bank guarantee, which only shields the buyer from a non-performing seller, SBLCs, depending on the type of SBLC issued, shield both the buyer and the seller.

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