Financing to your business may not be easy at all times. But you have to know the possible financing sources to mitigate your problems. You should know about some powerful tools that may give you an easy solution to reduce the fund constraints that you are facing right now . Standby Letter of Credit is one of the powerful tools that can support a non-funded facility to mitigate your financial issues.
Definition of Standby LC
Standby Letter of Credit is one type bank guarantee where the bank gives an assurance for the payment to the exporter on behalf of its clients (importer), if the clients (importer) fails to pay the payments for the goods, the bank will pay to the customers on behalf of its client and realize subsequently.
It is used in international trade and in domestic transactions. In a word, the standby letter of credit happens when importer fails to pay for the payment.
Types
There is two types standby letter of credit, such as :
- Financial Standby Letter of Credit
- Performance Standby Letter of Credit
Financial Standby LC:
Financial Standby letter of Credit is a letter of credit where the bank’s gives guarantee on behalf of its client to the exporter. This is a hundred percent conversion factor and in case of exported goods this letter of credit is used,
Say for example, an exporter exported goods to its foreign customers who committed to pay within 60 days from the date of export but he was failed to pay the amount. In this respect the bank assures to exporter through Financial Standby Letter of credit that payment will be made under any circumstances and will reimburse within due date.
Performance Standby LC:
This Letter of credit is using in case of construction contracts, or any other contracts. Through the performance letter of credit, a contractor promises to complete the work within a timely manner, and will maintain the compliance as per terms and condition of the agreement.
Performance letter of credit is an irrevocable letter of credit and issues to the developer or contractor for the compensation.
Steps to Open Letter of Credit
Step -01: The importer will request to his to open a Standby Letter of credit. In this respect, the importer will provide sufficient documents regarding his credit history and collateral (security) details.
Step -02: After receiving the documents, the bank verifies these. If satisfied bank opens a letter of credit in favor of them and sends it to the exporter’s bank
Step -03: Exporter receives the Letter of Credit and reviews the terms and conditions as mentioned in the letter of credit. If satisfied, he will proceed for the export.
Step – 04: Exporter shipped the exported goods and sends the documents to the importer’s bank for the payment.
Step -05: After receiving the documents importer’s bank will pay the obligations as mentioned in the LC.
Security/Collateral
For the following reasons collateral/security is needed to open a Standby Letter of Credit:
- The buyer may suffer for serious fund crisis and he may not be able to pay the obligations
- The buyer may quit the business
- The buyer’s asset may get frozen due to political stability
- The buyer may unhappy with the seller
- The buyer may dishonest
Procedures
- For Making the Payment: If you want a standby letter of credit, you may request your bank to issue a standby letter of credit. You have to communicate with commercial division or international trade department. You may review the payments terms & conditions and may hire an attorney to review the documents with you.
- For receiving the Payment: If you want somebody will use a standby letter of credit, you have to insist to issue an Irrevocable-letter-of-credit. You have to closely work with your bank and your attorneys regarding the conditions of collecting the payments.
Difference Between Standby and Commercial LC
| Standby Letter of Credit | Commercial Letter of Credit |
| This Letter of credit is the secondary payment methods where primary payment methods seems to be riskier. In standby letter of credit the bank works as guarantor of the payment where the bank ensure to the supplier for the payment. | Commercial Letter of Credit considered as the primary payment method of international transaction. In this case, the importer request to his bank to open a letter of credit in favor of the exporter to pay for the goods. After shipping the goods, the exporter sends the documents to the importer’s bank for the payment. |
| The Governing rules ISP 98 and UCP 600 are applicable | The Governing rules UCP 600 is applicable |
| Documentary requirements are easier than the commercial letter of credit in order to reach the payment. | The documentary process is relatively detailed and complex in order to reach the payment. |