In 2023, global trade was worth over $32 trillion, and a large part of this was secured through financial tools like Standby Letters of Credit (SBLC). An SBLC is a promise made by a bank to pay a seller if the buyer fails to make a payment. It’s a safety net that provides assurance in business deals. For businesses involved in international trade, an SBLC helps ensure trust between buyers and sellers, even when they don’t know each other well. By offering a guarantee of payment, SBLCs can help businesses manage risks and build stronger relationships, making them a crucial part of the global trading system.
In this blog, let’s understand Standby Letters of Credit (SBLC), its type, the process, and more.
What is a Standby Letter Of Credit (SBLC)?
A Standby Letter of Credit (SBLC) is a legal promise made by a bank to pay a seller if the buyer does not pay on time. This means if the buyer cannot pay for any reason, the bank will pay the seller instead.
An SBLC works like a safety net for exporters in international trade. It helps ensure that the seller gets paid on time for the goods they ship or the services they provide. Banks issue SBLCs to reduce the risks associated with international payments. These risks can include long distances, lack of trust between the buyer and seller, or different laws in each country. Overall, an SBLC gives peace of mind to both parties involved in the trade.
Types of Standby Letters of Credit
Now that you understand what an SBLC is, let’s talk about the different types of Standby Letters of Credit. There are several kinds, but the two main types are Financial SBLC and Performance SBLC. Here’s a breakdown of each one, along with some other types you might encounter:
1. Financial Standby Letter of Credit
A Financial Standby Letter of Credit is when a bank promises to pay a seller for goods or services if the buyer doesn’t pay within the agreed time. For example, suppose an exporter sends goods to a buyer in another country with a promise to get paid within 60 days. If the payment doesn’t arrive, the exporter can go to the buyer’s bank to get paid instead.
2. Performance Standby Letter of Credit
A Performance Standby Letter of Credit is used when a bank guarantees that a specific project will be completed as promised. This type of SBLC is less common and ensures that a project will be finished on time. If the person or company responsible for the project doesn’t complete it, the bank will pay the client. For example, if a construction contractor fails to build an office as agreed, the bank will cover the costs.
3. Advance Payment SBLC
An Advance Payment SBLC offers protection when one party in a contract fails to pay an advance amount. It ensures that the other party receives the agreed-upon advance payment.
4. Bid Bond/Tender Bond Standby
A Bid Bond or Tender Bond Standby provides security if a party fails to complete a project after winning a bid or tender. It ensures the project is completed as promised.
5. Counter Standby
A Counter Standby, also known as a backstop, is when a bank in one country requests another bank in a different country to issue a standby payment guarantee. It provides an extra layer of security for international transactions.
6. Direct Pay SBLC
A Direct Pay SBLC is issued when the applicant cannot make payments due to financial difficulties. It ensures the seller receives payment directly from the bank.
7. Insurance Standby Letter of Credit
An Insurance Standby Letter of Credit offers security if the applicant applies for insurance but cannot fulfill the requirements. It protects the beneficiary in case of failure to obtain insurance coverage.
These different types of Standby Letters of Credit provide various protections to both buyers and sellers in international trade, ensuring that transactions are secure and reliable. Each type serves a specific purpose, offering peace of mind in business deals.
Parties Involved in the Standby Letters of Credit Process
When using a Standby Letter of Credit (SBLC), several key parties are involved. Here’s a simple breakdown of each one:
1. The Applicant
The Applicant is the person or company that applies for the Standby Letter of Credit. This is usually the buyer who needs a guarantee from the bank that they will pay the seller on time.
2. The Issuing Bank
The Issuing Bank is the bank of the applicant (buyer) that issues the Standby Letter of Credit. It promises to pay the seller if the buyer fails to do so.
3. The Beneficiary
The Beneficiary is the person or company that will receive the payment, often called the seller or exporter. The Standby Letter of Credit is issued in their favor, providing them security that they will get paid.
4. Confirming Bank
The Confirming Bank is another bank that agrees to add its guarantee to the Standby Letter of Credit at the request of the Issuing Bank. This means the Confirming Bank also promises to pay the Beneficiary if the buyer does not pay.
5. Advising Bank
The Advising Bank is the bank that receives the Standby Letter of Credit from the Issuing Bank and forwards it to the Beneficiary. It may also help the Beneficiary with any collections or paperwork related to the SBLC.
These parties work together to ensure that both the buyer and seller feel secure in their international transactions. The Standby Letter of Credit acts as a safety net, making sure payments are made as promised.
How Does a Standby Letter of Credit Work?(H2)
What is SBLC?
A Standby Letter of Credit (SBLC) is a popular and trusted type of trade finance that helps protect sellers worldwide from the risk of not getting paid or not having a contract fulfilled. But how does someone apply for it?
Applying for an SBLC
The process of getting an SBLC is quite similar to applying for a commercial loan. However, in this case, the bank might ask for some collateral (something valuable) as security if the applicant can’t pay back the amount.
Here is a simple step-by-step guide to getting a standby letter of credit:
Request from Buyer: The buyer (importer) asks their bank or financial institution to issue a Standby Letter of Credit in favor of the seller (exporter). Before this, the buyer should know what a standby letter of credit means and how it works.
Bank Verification: The bank checks the buyer’s creditworthiness to see if they can be trusted with the finance. This might include looking at the buyer’s credit history and CIBIL ratings.
Approval or Denial: If the bank is unsure about the buyer’s reliability or ability to pay, they might decide not to provide the SBLC.
Collateral Requirement: If the transaction involves a large amount of money, the bank might ask for collateral. The size of the collateral depends on how risky the transaction is.
Additional Information Needed: The bank will need some extra information such as the seller’s name and address, company details, the period for which the SBLC is needed, and shipping documents.
Issuing the SBLC: Once the bank is satisfied with the buyer’s creditworthiness and all documents are in place, it issues the Standby Letter of Credit in favor of the beneficiary (the seller).
Agreement Fulfillment: If the buyer fulfills all the terms of the SBLC agreement, such as paying the exporter before the due date for the goods or services, the bank will terminate the agreement without any extra charges to the buyer.
Pro Tip
Importers and exporters involved in international trade should understand the meaning of a standby letter of credit. Remember, a Standby Letter of Credit is not meant for securing a transaction from the start but comes into play when one party defaults. The beneficiary needs to provide proof of this default to take action.
Also Read: The Intricacies of Back-to-Back Letters of Credit: A Comprehensive Overview
Importance of Standby Letters of Credit in Global Trade
A Standby Letter of Credit (SBLC) is a financial document used in international trade. It is especially useful when large sums of money are involved and there are associated risks. An SBLC offers several benefits for conducting international trade transactions. Here are some of the major advantages:
1. Safe Business Expansion Globally
The biggest benefit of a Standby Letter of Credit is that it helps build trust between businesses involved in international deals. When two parties don’t know each other or haven’t met in person, a standby LC acts as a safety net. It makes it easier to expand your business globally by establishing reliable and secure relationships with new trade partners.
2. Highly Customizable
A Standby Letter of Credit can be tailored to fit the needs of both parties involved. Importers and exporters can include their own terms and conditions in the agreement, as long as both parties agree. This makes it flexible, allowing changes to be made for different transactions with the same partner.
3. Assurance of Payment for the Seller
With an SBLC, sellers are assured that they will be paid on time. This is known as the SBLC payment. If the importer fails to pay, the exporter can present documents to the issuing bank. The bank then verifies these documents against the terms of the contract. If everything checks out, the bank pays the exporter the full amount.
4. Proof of Creditworthiness for the Buyer
An SBLC acts as proof that the buyer is creditworthy. This means that the buyer is financially stable and can afford to pay for the goods or services. Having this document makes it easier for the buyer to conduct multiple transactions at once, as they have the backing of a reliable financial institution.
5. Protection from Credit Risk for the Seller
A Standby Letter of Credit protects sellers from the risk of non-payment. Even if the buyer goes bankrupt, the creditworthiness is transferred to the issuing bank. This means the seller can still recover their money from the bank as per the agreement in the SBLC. Thus, it protects the seller from both payment and credit risk.
Also Read: Diverse Types of Export Letters of Credit
Pro Tips for Using Standby Letters of Credit
Neutral Bank: The bank that provides the Standby Letter of Credit (SBLC) should be a neutral third party. This means it should not favor the buyer or the seller, but act fairly for both parties.
Assurance for Buyer and Seller: The SBLC assures the buyer that they will receive the goods and services they paid for, and it assures the seller that they will get paid. However, it does not guarantee the quality of the goods. So, it’s important to understand what an SBLC really means.
Payment Guarantee: The bank promises to pay the full or remaining amount to the exporter if they meet all the conditions of the SBLC agreement. This ensures that the seller gets paid as long as they do everything as agreed.
Issuing the SBLC: A bank or financial institution can issue a Standby Letter of Credit as an import finance tool after checking the applicant’s creditworthiness. This means they will verify if the buyer is capable of paying for the goods.
Common in International Trade: The Standby Letter of Credit is one of the most commonly used tools in global trade transactions. It helps make international trade safer and more reliable for both buyers and sellers.
Also Read: LC at Sight: Meaning & Complete Process
Conclusion
In conclusion, a Standby Letter of Credit (SBLC) is an essential financial tool that helps make international trade safer and more reliable. It provides a guarantee of payment, helping businesses build trust with new partners and manage risks. By understanding the different types of SBLCs and how they work, both buyers and sellers can benefit from secure transactions. Overall, SBLCs are crucial for businesses looking to expand globally and ensure smooth, successful trade deals.
Also Read: Standby Letter of Credit (SBLC): Grasping Its Meaning, Varieties, and Operational Mechanism
