A standby letter of credit (SBLC) is defined as a legal document that testifies that the bank named on it (the document) guarantees to pay a certain sum of money to the seller if the buyer fails to stick to the purchase agreement.

Experts describe SBLCs as safety nets for payments made to sellers for completed services or shipment of goods. This special document helps sellers if any unforeseen circumstances stop the buyer from paying as scheduled.

A Brief Introduction to the Idea of SBLC

Top SBLC providers believe that before using SBLC sellers must know the nitty-gritty of the concept. As a first-timer, you must perceive SBLCs as a tool used in domestic or international transactions involving sellers and buyers who don’t know each other.

The primary goal of SBLCs is hedging out risks such transactions usually involve. Two common examples of risks are insufficient cash flow and bankruptcy which the buyers in question might be dealing with. Such events stop buyers from paying for the services and goods they purchase on time. The SBLC ensures that even if there’s any adverse event, the seller gets the necessary amount from the bank. However, to get the amount, sellers will need to meet all the criteria of the concerned SBLC.

Here, you must remember that monetizing SBLC is equivalent to a credit. It would be the duty of the buyer to pay back the amount, which would include both principal (the cost of the goods/services) and interest imposed by the bank.

Standby Letter of Credit for International Transactions

The frequency of using SBLC is higher in international trade. It makes it easier for businesses to build trust and obtain a contract. When the parties involved are from different countries it’s unlikely that they would know each other. Having the letter helps the seller have maximum confidence in the transaction. For the buyer, on the other hand, SBLC stands as the testimony of credit quality, i.e., his/her ability to pay for goods/services defying the odds.

The financial organization offering the SBLC to the buyer always verifies the person’s (or business’s) credit quality before issuing the letter. SBLCs are issued only when the financial organization is happy with the credit standing of the buyer. The buyer's bank typically notifies the seller’s bank about its commitment to pay the seller a certain amount in case the buyer doesn’t pay according to the agreement.

The Working Procedure of SBLCs

The steps of applying for an SBLC are a lot like those you will need to complete to apply for a loan. You will need to fill out a form with personal details and details of your business and submit it to the financial organization you want the letter. The recipient body will carry out due diligence to ensure that you have the credentials to receive the SBLC. It will assess your creditworthiness by checking your credit history and latest credit report.

For individuals with a questionable credit history, financial organizations may require an asset as collateral to approve the SBLC application. It’s also common for banks to ask for the associated funds to be deposited as collateral. Multiple factors decide the levels of such collaterals. Some of the most crucial ones among them include the business’s strength, the amount of risk involved in the transaction, the amount of money involved in the transaction, etc.  

Other than sharing detailed information about his/her business, the buyer also needs to share detailed seller information with the financial organization issuing the SBLC. Additionally, he/she will also need to submit shipping documents needed for payment and bank details of the beneficiary (the seller). Last but not least it’s also mandatory for the buyer to inform the seller and his or her bank about the period for which the SBLC would be valid. Yes, every SBLC comes with an expiry date.

Once the SBLC is issued, the buyer would need to pay a service fee every year till the time the document is valid. Usually, the fee amount ranges from 1 to 10% of the sum covered by the SBLC.

The issuing organization usually terminates the SBLCs the moment the buyer meets all obligations of the contract. The termination takes place even if the obligations are met prior to the due date. What’s more, the buyer doesn’t need to bear any additional expenses for early termination of the agreement.

Sellers using the SBLC to receive payment due to the buyer’s failure to make the same need to submit a series of documents for a successful transaction. To be more precise, they will need to submit all the documents listed on the SBLC to the bank issuing the letter. If the bank is satisfied with the documents received, it will transfer the required amount to the seller’s account.

Types of SBLCs

SBLCs are usually of two types. They are:

Financial SBLCs: These are tools that guarantee payment when a buyer doesn’t pay for products/services as per the contract.  These contracts usually feature clauses that mention the period for which the seller should wait before using the SBLC to get the amount. The SBLC would come into action only after the said waiting period.

Performance SBLCs: Performance SBLCs guarantee project completion within a specific period. You will need to monetize SBLC if the client of the bank issuing the SBLC fails to complete the project within the specified time. In such events, the bank pays a certain amount as reimbursement for loss of time and subsequent suffering.

The use of performance SBLCs has become common in projects that are meant to be completed within a certain time. Examples include construction projects. Monetization of a performance SBLC means the project owner is paying a penalty for the delay in the completion of the project.  

Final Words

If you want to increase your trustworthiness among buyers, ensure you are backed by a powerful SBLC. Get a letter of credit from a trusted bank or financial organization to enjoy the maximum benefits of this financial tool.