Standby Letters of Credit - Meaning & Its Types

A standby letter of credit is a legal payment assurance given by a bank or a financial institution to the beneficiary against any default made by its applicant (buyer). In simple words, the issuing bank guarantees the fulfillment of the buyer’s contractual obligations in case of the buyer’s incapability and offers the security of payment to the seller by reimbursing the full or remaining amount. Unlike other types of LCs (Letters of Credit), SBLCs are secondary payment instruments whereby the banks are only required to make the payment in the event if the buyer defaults. In the case of LCs, the banks make the payment first and then recover it from the applicant at a later date. It is one of the most used trade finance instruments in international trade transactions. The issuance of standby LCs will only take effect if the applicant defaults on its duties mentioned under the SBLC contract. To conclude, we can say that it is a legal document where a bank guarantees an on-time payment to the seller in case the buyer is at default. Types of Standby LC 1. Financial Standby Letter of Credit This type of Standby LCs comes with an irrevocable undertaking made by the bank guaranteeing the buyer’s obligation to pay to the seller. To put it simply, the bank ensures that the suppliers in international trade deals will get the payment for the delivered goods even if the buyer defaults.