Standby Letter Of Credit
Introduction to
Standby Letter of Credit
A Standby Letter of Credit (SBLC) is a financial instrument issued by a bank that serves as a safety net in transactions between parties. If the customer (applicant) fails to meet their payment obligations, the bank guarantees payment to the beneficiary. Unlike public trading securities, SBLCs are private agreements and do not involve public trading.
Key Benefits of Standby Letters of Credit
- Improves Cash Flow: Reduces the need for upfront cash payments or collateral, freeing up funds for other uses.
- Reduces Collateral Requirements: Eliminates or reduces the need for cash collateral to secure performance obligations
- Prevents Prepayment: Allows you to avoid prepaying for products or services, letting you use your funds for other purposes until payment is due.
- Enhances Bidding: Provides financial security that can help you win contracts by ensuring payment performance.
Who Are the Parties Involved?
- The Applicant: The customer of the bank who requests the standby letter of credit. They must provide collateral or have sufficient credit, and pay a fee for the issuance.
- The Issuing Bank: The bank that issues the standby letter of credit on behalf of the applicant.
- The Beneficiary: The party to whom the standby letter of credit is issued and who will receive payment if the applicant defaults.
- Confirming Bank: A bank (often near the beneficiary) that agrees to pay the beneficiary if the issuing bank fails. The confirming bank collects the payment from the issuing bank.
- Advising Bank: The bank that informs the beneficiary about the letter of credit and may assist in its processing. It may also act as the confirming bank.
Purpose of a Standby Letter of Credit
A Standby Letter of Credit functions like a bank guarantee. It is payable upon demand without needing to resolve disputes between the applicant and the beneficiary. The beneficiary decides if they will accept the standby letter of credit.
Types of Standby Letters of Credit
- Performance Standby: Covers obligations beyond payment, like losses from the applicant’s failure to complete a transaction.
- Advance Payment Standby: Secures advance payments made by the beneficiary to the applicant.
- Bid Bond/Tender Standby: Ensures the applicant will execute a contract if awarded a bid.
- Counter Standby: Supports the issuance of another standby or similar undertakings by the beneficiary.
- Direct Pay Standby: Ensures payment due under an obligation, usually linked to financial standbys.
- Insurance Standby: Represents an insurance or reinsurance obligation.
- Commercial Standby: Covers payment obligations for goods or services if the applicant fails to pay.
Transferability of Standby Letters of Credit
- Assignment of Proceeds: The beneficiary can assign the proceeds to another party. However, only the beneficiary can demand payment from the bank unless the terms state otherwise. Notice must be given to the issuing bank for the assignment.
- Transfer of Standby Letters of Credit: Transfer to a third party requires written consent from both the issuing bank and the beneficiary.
Trading of Standby Letters of Credit
Standby Letters of Credit are not publicly traded or subject to Securities and Exchange Commission (SEC) regulations. They do not have CUSIP or ISIN numbers and can only be transferred or assigned in private transactions.