BTL 720 - Standby LC

 

The Banking Tutor’s Lessons

BTL 720                                                                             03-11-2024

Standby LC

 

After Second World War, Banks in the US were not allowed to issue guarantees. Then they found that if they changed the format of the guarantee slightly they could adapt a Letter of Credit in such a way it became de facto a “bank guarantee”. Japanese Banks also issue Standby Credits for similar reasons. In short Standby LC is a bank guarantee in LC format.

 

A Standby Letter of Credit (SBLC / SLOC) is a guarantee that is made by a bank on behalf of a client, which ensures payment will be made if their client cannot fulfil the payment.

 

SBLC covers the beneficiary (/seller) and offers financial compensation in case of the applicant (/buyer) defaulting on its named obligation (financial or otherwise) i.e. it guarantees financial compensation in case of a claim in conformity with the instrument and the underlying rules. So contrary to a “normal” LC you would only draw under the SBLC in case something goes wrong.

 

An SBLC is frequently used as a safety mechanism for the beneficiary, in an attempt to hedge out risks associated with the trade. It is also perceived as a “payment of last resort” due to the circumstances under which it is called upon.

 

Furthermore, the presence of an SBLC is usually seen as a sign of good faith as it  provides proof of the buyer’s credit quality and the ability to make payment.

 

Essentially, it is an insurance mechanism to the company that is being contracted with.

Difference between SBLC and LC

 

An SBLC is paid when called on when conditions have not fulfilled. However, a Letter of Credit is the guarantee of payment when certain conditions are fulfilled and documents received from the selling party. In the event that there is non-payment, the seller will present the SBLC to the buyer’s bank so that payment is received.

 

A letter of credit is a short-term instrument, where the expiry is usually 90 days. A standby letter of credit is a long-term instrument, (validity is usually one year or so.)

 

Difference between SBLC and Bank Guarantee :

 

Level playing field - Bank Guarantees (except for those under UDRG 758 ) are subject to a certain law and jurisdiction, which is either that of the applicant or the beneficiary. However, in case of SBLC, the underlying rules are either UCP or ISP.

 

Expiry date - a guarantee can be open ended, a SBLC can not be open ended.

ICC (International Chamber of Commerce) formulated a separate set of rules relating to SBLC in 1998 known as International Standby Practices (ISP-98), ICC Publication No 590 which has come into force on 01-01-1999.

 

ISP- 98 reflects the generally accepted practices, customs and usage of Standby LCs.

 

Standby LC can perform the functions of various guarantees like Advance Payment Guarantee, Performance Guarantee etc. by suitably amending the wordings.

 

Banks in India are allowed to issue only Commercial SBLCs for importing goods into India.

Sekhar Pariti

+91 9440641014