Standby Letter of Credit (SBLC) is a type of letter of credit (LC) where the issuing bank commits to pay to the beneficiary if the applicant fails to make the payment. SBLCs, unlike other types of LCs, are a type of contingency plan. In the case of other LCs, the bank makes the payment first, and then the applicant pays to the bank at a later date. However, when a bank issues an SBLC, they are only required to make the payment if the buyer or the applicant defaults. Any bank or NBFC can issue an SBLC once they are confident about the creditworthiness of the applicant. This is because the banks or the issuing institutions are exposed to the highest risk in the process.
An SBLC is frequently used as a safety mechanism for the beneficiary, in an attempt to hedge out risks associated with the trade. Simplistically, it is a guarantee of payment that will be issued by a bank on the behalf of a client. It is also perceived as a “payment of last resort” thanks to the circumstances under which it’s called upon. The SBLC prevents contracts from going unfulfilled if a business declares bankruptcy or cannot otherwise meet financial obligations. Furthermore, the presence of an SBLC is typically seen as a symbol of excellent faith because it provides proof of the buyer’s credit quality and therefore the ability to form payment. To line this up, a brief underwriting duty is performed to make sure the credit quality of the party that’s trying to find a letter of credit. Once this has been performed, a notification is then sent to the bank of the party who requested the Letter of Credit (typically the seller). In the case of a default, the counter-party may have a part of the finance paid back by the issuing bank under an SBLC. Standby Letters of Credits are wont to promote confidence in companies due to this. A standby letter of credit, abbreviated as SBLC, refers to a legal instrument where a bank guarantees the payment of a selected amount of cash to a seller if the buyer defaults on the agreement. An SBLC acts as a security net for the payment of a shipment of physical goods or completed service to the vendor, in the event something unforeseen prevents the customer from making the scheduled payments to the seller. In such a case, the SBLC ensures the specified payments are made to the vendor after the fulfilment of the specified obligations.
A standby letter of credit is employed in international or domestic transactions where the vendor and therefore the buyer don’t know one another, and it attempts to hedge out the risks associated with such a transaction. Some of the risks include bankruptcy and insufficient cash flows on the part of the customer, which prevents them from making payments to the vendor on time. In case of an adverse event, the bank promises to form the specified payment to the vendor as long as they meet the wants of the SBLC. The bank payment to the vendor may be a sort of credit, and therefore the customer (buyer) is liable for paying the principal plus interest as agreed with the bank.