What is a Standby Letter of Credit (SBLC/SLOC)?

A Standby Letter of Credit (SBLC/SLOC) is a financial instrument issued by a bank on behalf of a client, promising payment to a beneficiary in case the client fails to fulfill their contractual obligations. A Standby Letter of Credit can also be a guarantee of payment. Unlike a traditional letter of credit, a Standby Letter of Credit only comes into effect if the client defaults, serving as a “safety net” or backup.

A standby letter of credit helps facilitate international trade between companies that don’t know each other and have different laws and regulations. Although the buyer is certain to receive the goods and the seller is certain to receive payment, a Standby Letter of Credit doesn’t guarantee the buyer will be happy with the goods. A standby letter of credit can also be abbreviated SBLC or SLOC.

Key Features of a Standby Letter of Credit:

1. Purpose: A Standby Letter of Credit is used in international trade and high-value transactions to reduce the risk for the seller/exporter by guaranteeing that they will be paid if the buyer defaults.
2. Activation: The SBLC becomes active and payable only when specific conditions are met, such as the buyer failing to pay or not fulfilling their contract.
3. Process: To draw on the Standby Letter of Credit, the beneficiary must provide proof of default (like shipping documents or invoices) as per the terms agreed upon.
4. Governing Rules: Standby Letters of Credit are typically governed by international guidelines like UCP 600 (Uniform Customs and Practice for Documentary Credits) or ISP 98 (International Standby Practices), which ensure uniformity in global transactions.

How a Standby Letter of Credit Works

A Standby Letter of Credit (SBLC) is commonly used in both international and domestic transactions where the buyer and seller may not know each other well. It acts as a safety net for the beneficiary (seller), providing a guarantee of payment issued by a bank on behalf of the buyer (applicant). Essentially, it is a “payment of last resort” and is only called upon when the buyer fails to meet the financial obligations.

Key Functions:

• Risk Mitigation: The SBLC protects against the risk of a buyer declaring bankruptcy or experiencing cash flow issues that prevent timely payments.
• Assurance of Contract Fulfillment: It ensures that contracts are fulfilled even if a buyer faces financial distress.

However, the SBLC’s protection is only effective if the terms are followed exactly. Even small errors, such as misspelling a company’s name or shipping delays, can result in the bank refusing to honor the payment.

Perception and Trust:

The presence of an SBLC is often seen as a sign of good faith and credibility, as it demonstrates the buyer’s creditworthiness and ability to make payments, which can build trust between parties.

In international trade, a Standby Letter of Credit (SBLC) serves as a form of insurance for transactions. It guarantees payment if the buyer (applicant) defaults, providing security for the seller (beneficiary).

Advantages of a Standby Letter of Credit (SBLC):

• Trust Builder: A Standby Letter of Credit demonstrates the buyer’s commitment, making it easier to secure deals, especially for smaller businesses.
• Payment Assurance: The seller is guaranteed payment if the buyer fails to fulfill their obligations, reducing risk in complex transactions.
• Flexible Payment Options: Allows buyers to extend payment terms while ensuring sellers are protected.
• Stronger Negotiation: Lower risk can lead to better terms for both parties.

Disadvantages of a Standby Letter of Credit (SBLC):

• Costly Business: SBLCs can be expensive to obtain.
• Documentation Demands: Requires extensive paperwork and compliance.
• Buyer’s Burden: The buyer must prove their creditworthiness.
• Quality Concerns: If goods or services are subpar, the SBLC may not cover disputes.
• Bank Failure Risk: The issuing bank’s insolvency could jeopardize payment security.

Types of Standby Letter of Credit

The two main types of standby letters of credit are:

1. Financial SBLC

The financial-based SBLC guarantees payment for goods or services, as stipulated in the agreement. For example, if a crude oil company ships oil to a foreign buyer with an expectation that the buyer will pay within 30 days from the date of shipment, and the payment is not made by the required date, the crude oil seller can collect the payment for goods delivered from the buyer’s bank. Since it is a credit, the bank will collect the principal plus interest from the buyer.

2. Performance SBLC

A performance-based SBLC guarantees the completion of a project within the scheduled timelines. If the bank’s client is unable to complete the project outlined in the contract, then the bank promises to reimburse the third party to the contract a specific sum of money.

Performance SBLCs are used in projects that are scheduled for completion within a specific timeline, such as construction projects. The payment serves as a penalty for delays in the project’s completion, and it is used to compensate the customer for the inconvenience caused or to pay another contractor to take over the project.

Standby Letter of Credit in International Trade. 

In international trade, a Standby Letter of Credit (SBLC) is often required to secure a business contract between unfamiliar parties. It serves as a guarantee of payment, promoting the seller’s confidence by assuring that the buyer has the financial backing to meet their obligations, even in the event of unforeseen circumstances. The Standby Letter of Credit is seen as a symbol of good faith, as it confirms the buyer’s creditworthiness and ability to pay for goods or services.

When setting up an SBLC, the buyer’s bank conducts an underwriting process to assess the buyer’s financial standing. Once the bank is satisfied with the buyer’s creditworthiness, it issues the SBLC to the seller’s bank, guaranteeing payment if the buyer defaults on the agreement. This process ensures that the seller has proof of the buyer’s ability to fulfill their financial obligations.

The benefits of a Standby Letters of Credit in International Trade

The standby letter of credit (SBLC / SLOC) is often seen in international trade contracts, which tend to involve a large commitment of money and have added risks.

For the business that is presented with a SLOC, the greatest advantage is the potential ease of getting out of that worst-case scenario. If an agreement calls for payment within 30 days of delivery and the payment is not made, the seller can present the SLOC to the buyer’s bank for payment. Thus, the seller is guaranteed to be paid. Another advantage for the seller is that the SBLC reduces the risk of the production order being changed or canceled by the buyer.

An SBLC helps ensure that the buyer will receive the goods or services that are outlined in the document. For example, if a contract calls for the construction of a building and the builder fails to deliver, the client presents the SLOC to the bank to be made whole. Another advantage when involved in global trade, a buyer has an increased certainty that the goods will be delivered from the seller.

Also, small businesses can have difficulty competing against bigger and better-known rivals. A standby letter of credit can add credibility to its bid for a project and can often help avoid an upfront payment to the seller.

Standby Letter of Credit Process

The Standby Letter of Credit (SBLC / SLOC) process generally involves the following steps:

• The buyer applies to their bank for an SBLC in favor of the seller.
• The issuing bank conducts due diligence on the buyer’s creditworthiness and financial standing.
• If the issuing bank is satisfied with the buyer’s application, it issues the SBLC to the seller’s bank.
• The seller’s bank receives the SBLC, confirms its authenticity, and notifies the seller.
• The seller ships the goods or provides the services as per the terms of the contract.
• If the buyer fails to make payment, the seller submits the necessary documents to the issuing bank to draw on the SBLC.
• The issuing bank pays the seller the amount specified in the SBLC.

Standby Letter of Credit Costs

When a bank issues a Standby Letter of Credit (SBLC), there are associated fees. Typically, banks charge a service fee ranging from 1% to 10% annually for the duration the SBLC remains valid. If the buyer fulfills their obligations in the contract before the due date, the bank will terminate the SBLC without an additional charge to the buyer. However, at General Credit Finance and Development Limited, our SBLC leasing fee is 4% annually. Additionally, there is a 2% broker commission if the deal is introduced by a broker. This broker fee does not apply if there is no broker involved in the transaction.

Standby Letter of Credit (SBLC) Monetization

Standby Letter of Credit (SBLC) Monetization is the process of liquidating a Standby Letter of Credit (SBLC) into cash or legal tender. It simply refers to converting the SBLC into cash or liquid assets, usually through a process where the holder of the instrument can sell or use it as collateral to access funds.

If a company needs a loan or line of credit, it can “lease” a Standby Letter of Credit (SBLC) from an SBLC provider like General Credit Finance and Development Limited. There are many so-called SBLC providers in many countries but one has to be careful to avoid being scammed because there are many SBLC scammers all over the place. In the coming days, we will write a detailed article on how to spot fake SBLC providers.

SBLC Monetization Process

SBLC monetization involves converting a Standby Letter of Credit (SBLC) into cash or legal tender. General Credit Finance and Development Limited is a leading SBLC monetization company with decades of experience. Over the years, we have built strong relationships with top banks worldwide, enabling us to monetize Standby Letters of Credit for clients globally. We can facilitate and support clients in monetizing their Standby Letter of Credit from rated banks. The Standby Letter of Credit Monetization arrangement provides Non-Recourse funds to the Client within 10 days after the Standby Letter of Credit (SBLC) is monetized.

– How It Works

1. Obtain an SBLC
   To monetize an SBLC, the client first needs to acquire the Standby Letter of Credit from their bank. This process may involve providing the bank with key information, such as the client’s financial history, creditworthiness, and the specifics of the obligation the SBLC will secure. If you do not have an SBLC, General Credit Finance and Development Limited will provide the SBLC and still monetize it under one roof without involving a third party. We are the only company offering this SBLC inhouse issuance and monetization service. 
2. Find a Lender
   Next, the client must identify a lender willing to provide a loan using the SBLC as collateral. The lender might request additional information, including the SBLC’s terms and conditions, the issuing bank’s creditworthiness, and details of the underlying obligation. As explained above, General Credit Finance and Development Limited takes this burden off your shoulders by issuing and monetizing the SBLC in-house.
3. Negotiate Terms
   The client will then negotiate the loan’s terms with the lender, covering aspects such as the loan amount, interest rate, and repayment schedule.
4. Sign an Agreement
   After agreeing on the terms, both parties will sign a loan agreement. This document outlines the loan conditions and the rights and responsibilities of both the client and the lender.

Where can I apply for a Standby Letter of Credit?

Standby letters of credit are typically offered by banks and licensed lenders such as General Credit Finance and Development Limited. Usually, the bank will assess the creditworthiness of the applicant like in a loan application. You’d usually need to contact their trade finance department. If you’re unsure where to start, and depending on your location, banks like Standard Chartered, HSBC, Barclays Bank, General Credit Finance and Development Limited might be good places to start in Nigeria. Keep in mind that each bank might have different requirements and procedures. Happy hunting

When would you need an SBC?

Standby letters of credit are often used in international trade deals where the terms may be different between parties, but that is not the only use. Anytime a buyer needs to guarantee payment for goods or services, a SBLC may be in order.

What is a Standby Letter of Credit provider?

A Standby Letter of Credit (SBLC) provider is typically a bank or financial institution, such as General Credit Finance and Development Limited, that issues SBLCs on behalf of their clients. These institutions offer a range of tailored financial services, including business loans, trade finance, bank guarantees, and SBLCs, to customers that meet the funding requirements. The SBLC acts as a guarantee of payment, ensuring that the beneficiary will receive payment even if the client cannot fulfill their financial obligations. Essentially, it’s a safety mechanism used in trade transactions to mitigate risks.

SBLC providers are selected based on their reputation, credibility, and the strength of their financial backing, and this is what sets General Credit Finance and Development Limited apart from other BG/SBLC providers. General Credit Finance and Development Limited is a Licensed Financial Services Provider (FSP) that was incorporated in Hong Kong on APRIL 03, 1973 with company registration number 0032754.  

Since our incorporation in 1973, we’ve been the trusted choice for businesses across the globe, offering tailored financial solutions such as Business Loans, SME Loans, Collateral Transfer, Bank Financial Instruments, Standby Letters of Credit (SBLC) and Bank Guarantees (BG) etc.

Website: https://www.gcfdl.com  ||  Email: info@gcfdl.com

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To keep learning and developing your knowledge of global trade and finance, we highly recommend the additional resources below:

• UNDERSTANDING BG/SBLC MT760
• Bank Guarantees vs. Standby Letters of Credit
• What is International Trade?