Letters of credit has been widely used in various trade finances, especially in the cases where the buyer and the seller are not known to each other, are living in different countries or have different laws to trade. One such letter of credit is Standby credit.
Now, generally when two parties come into a contract to purchase and sell a product, the seller promises to deliver the goods on the payment of a specified amount. At times this payment can be agreed to be paid at a later date on the fulfilment of certain terms and conditions. But it may so happen that even after being bound by a contract the purchaser refuses to make the payment or becomes unable to make the payment after the delivery of goods. To mitigate the loss that the seller may incur under the aforesaid circumstances, the parties may use a standby letter of credit.
Under a standby letter of credit, the issuing bank (or the buyer’s bank) gives the assurance to make the payment even after the buyer has failed to do so.
SBLC is a safety measure adopted by the beneficiary (Seller) to safeguard the risks associated with the business. Simply speaking, it is a guarantee made the bank on account of the buyer.
Advantages of using Standby Letter of credit:-
- The seller can still be accounted to be paid in case he is not able to present the conforming documents.
- The process is easier than any other documentary letter of credit.
- The seller doesn’t bear any burden of proof whether the goods were actually delivered or not.
Pre-requisites for obtaining the standby letter of credit-
- One must have appropriate evidences to show that he has the ability to pay the loan.
- Something must be presented to the bank as a collateral which will act as a security in case you are unable to pay.
- Once the bank is completely satisfied of your ability to pay the loan, after inspecting the documents presented by you, the bank will provide you in writing within a week’s time.
- A fee needs to be paid for every year the Standby letter of credit remains in effect.
- A fee of about 1-10% of the total monetary value of the letter of credit has to be paid.
Types of standby letter of credit.
There are 3 types of standby letter of credit.
- Financial SBLC
- Performance SBLC
- Revolving SBLC
- Financial SBLC- This is an irrevocable assurance made by the issuing bank to the seller in case the buyer fails to make the payment.
- Performance SBLC- This is an undertaking by the bank in the circumstance that the buyer has failed to make the payment. The bank promises to pay 50% of the value of the transaction when the buyer fails to make the payment.
- Revolving SBLC- It is issued by the bank to enable long-term business between an importer and an exporter and is used to cover multiple shipment contracts which may validate upto years.