What Is Standby Letter of Credit and How to Apply?

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What is Standby Letter of Credit

A standby letter of credit is like a legal document that provides a guarantee of a bank’s commitment to the seller in case the buyer or the client of the bank defaults on the contract. A standby letter of credit provides facilities of international trade to those companies which do not know each other and which have their different rules and regulations. However, the buyer is someone who gets the goods and the seller is someone who gets the payment, a standby letter of credit does not guarantee the buyer would be glad about the goods. 

How a Standby Letter of Credit works

A standby letter of credit is issued by a business to assist it to get a contract. This is a standby contract as the bank would only have to pay in a worst-case scene. However, a Standby letter of credit guarantees payment to the seller, the agreement should have complied exactly. For instance, the bank may refuse to pay because of shipping delays or misspelling of the company name. 

Process for Standby Letter of Credit

The process for getting a standby letter of credit includes you can apply to a bank, set up creditworthiness, and typically inserting cash deposit and make payment of a fee. 

The standby letter of credit is a written commitment of the bank that issued the letter of credit saying that the bank would make payment to the letter of credit beneficiary in case the client of the bank, applicant fails to make a payment to the beneficiary for the letter of credit. Necessarily, the standby letter of credit is the backup payment coverage form designed for a guarantee, the seller gets the money due to them from the buyer. This is obligatory to the beneficiary, as per the conditions of the standby letter of credit, on request, and the issuing bank can’t refuse to pay on account of any disagreement between the beneficiary and the applicant. 

The standby letter of credit is generally considered as a certificate of ability and creditworthiness of the applicant to make the essential payment to complete its contractual obligation of the standby letter of credit to the beneficiary. In case the bank issue a Standby Letter of credit ends up making payment to the beneficiary, it hopes, or at least expects, that applicant can payback. 

If you as a seller demands a standby letter of credit, you usually would want that it is an irrevocable letter of credit, that means the conditions of the Standby Letter of Credit can’t be changed without the consent of the beneficiary, then the applicant demands the standby letter of credit from its bank. The issuing bank usually views again the applicant’s creditworthiness before issuing the standby letter of credit. Most reliable applicants for a standby letter of credit are demanded to post a cash deposit covering a little part of the amount of the standby letter of credit, and they should also make the payment of a fee to the bank, usually 2-5% SLC amount. Then the applicant gives a confirmation letter from the bank to the beneficiary. 

Benefits of Standby Letter of Credit

The standby letter of credit is witnessed in contracts including international trade, that include a big commitment of fund and added risks. 

For a business that is offered with a Standby Letter of Credit, the biggest benefit is the probable ease of moving out of that most critical case situation. If a contract requires payment in 30 days of shipment and the amount is not paid, the seller can submit the standby letter of credit to the bank of the buyer for payment. Hence, the seller gives a guarantee to make the payment. Another benefit for the seller is that the standby letter of credit decreases the hazard of the buyer changing or canceling the production order. 

Moreover, small businesses may have complexity fighting against larger and more popular competitors. A standby letter of credit can increase trustworthiness to its proposal for a plan and can at times help the seller avoid paying upfront. 

Also read, What Is Bank Guarantee And How Does It Work

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