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Finance Guides
Standby Letter Of Credit Process Flow
Trade Finance
21 February 2023
STANDBY LETTER OF CREDIT PROCESS FLOW
WHAT IS SBLC?
‘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.
WHAT IS SBLC USED FOR?
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.
WHO CAN ISSUE SBCL?
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.
HOW TO GET SBLC?
In order to obtain a standby letter of credit, a buyer has to contact a bank and
establish their creditworthiness. The bank may ask for additional collateral if
the risk or the amount is too high. Once the buyer fulfills all the conditions
and the bank deems them fit for receiving the credit, the bank issues them an
SBLC and charges 1% to 10% of the total amount as an annual fee for as long as
the standby letter of credit is valid.
TYPES OF SBLC
The types of standby letter of credit are given below :-
1) FINANCIAL STANDBY LETTER OF CREDIT
A financial SBLC guarantees payment to the seller or the service provider for
the goods or the services rendered as per the agreement within the stipulated
time frame.
Example: If an edible dye manufacturer sends a shipment to a soft drink company
against a financial SBLC, and the company is unable to pay for it, the issuing
bank will step in and pay the manufacturer for the dye. Later on, the soft drink
company would have to pay the full amount and interest to the issuing bank.
2) PERFORMANCE STANDBY LETTER OF CREDIT
A performance SBLC is less commonly used compared to a financial SBLC.
Performance SBLCs provide a guarantee of completion of a project as per the
agreement or the contract. If the service provider fails to complete the project
within a stipulated time frame, the bank steps in and reimburses the client.
Example: An IT company hires a contractor to construct a new office. The
contractor agrees to complete the construction within a specific time frame but
fails to deliver. However, if this deal is protected by a performance SBLC, the
issuing bank will pay entire project fees to the IT company and will charge
penalties to the contractor. This acts as a safety check to ensure that heavy
budget projects are completed in a timely fashion.
3) ADVANCE PAYMENT SBLC
Advance Payment Standby LC provides security against one party’s failure to pay
the other party’s advance payment.
4) BID BOND/ TENDER SBLC
Bid bond/Tender Standby LCs act as a security against failure to complete the
project once the applicant has been awarded the bid or the tender for it.
5) COUNTER SBLC
Also known as a backstop or a protective standby, Counter SBLC is a type of LC
issued by a bank in one country to a bank in another country, asking them to
issue a new standby LC to their local beneficiary.
6) DIRECT PAY SBLC
Direct Pay SBLCs act as a security in the instance of financial instability of
the applicant. A direct pay standby is irrevocable.
7) INSURANCE SBLC
Insurance SBLC provides support to the beneficiary in case the applicant has
committed for insurance or reinsurance but fails to do so.
8) LEASE SUPPORT SBLC
A lease support SBLC is issued by the bank representing the tenant to the
landlord. The bank generally takes a deposit as collateral for the SBLC. It
pledges to pay the rent to the landlord in case the tenant is not able to do so.
HOW DOES AN SBLC WORK IN INDIA?
Here’s a step by step process of how an SBLC works:
1. The process of obtaining an SBLC is fairly simple and similar to that of
obtaining any other type of LC or a loan from a bank. A buyer simply walks
into a bank or a financial institution and applies for an SBLC.
2. The bank then starts looking into the creditworthiness of the applicant and
decides whether or not the person should be credited with the SBLC. The bank
looks into the financial history of the applicant as well as their credit
reports and ratings.
3. If the bank suspects that the buyer will not be able to honor the LC, they
may ask for additional collateral to be provided. The size of the collateral
depends on the risks as well as the nature of the business.
4. Once the buyer establishes sufficient creditworthiness, the bank asks for
the details of the agreement between the buyer and the seller. Information
such as the seller’s name and address, company details, the time period for
which SBLC is to be taken as well as shipping documents, etc., are submitted
to the bank.
5. Once the bank is satisfied with all the information at their disposal and
their background checks have yielded satisfactory results, it provides an
SBLC to the buyer. The bank charges 1% to 10% of the amount of SBLC as a
yearly fee, and it’s applicable until the SBLC is valid.
6. If the buyer meets its obligations in the contract before the due date, the
bank will terminate the SBLC without a further charge to the buyer. Once the
buyer pays the seller for the goods or the services, the bank terminates the
SBLC and doesn’t charge him beyond that point.
7. As discussed above, SBLC is not actually meant to be used and only acts as a
security against default. It comes into action if the buyer is not able to
honor the agreement with the seller, the seller goes to the bank and submits
the proofs as mentioned in the SBLC. Once the bank verifies the proofs, they
release the payment to the seller. The buyer then makes the payment to the
bank at a later date along with interest.
HOW MUCH DOES AN SBLC COST?
Of the total SBLC amount, banks charge about 1% to 10% as annual fees --
depending on the risks and the amount. The charges are applicable as long as the
SBLC is valid.
ADVANTAGES OF SBLC
BRIDGES TRUST DEFICIT
Lack of trust and fear of payment default is one of the key reasons why some
international trade deals don't take off. An SBLC is the best way to bridge the
gap and ensure that all the worst-case scenarios are dealt with.
SERVES AS A GREAT PROOF OF CREDITWORTHINESS
Once a reputed financial institution lends someone a standby letter of credit,
they’re practically making a statement about their and their company’s financial
situation. This goes a long way in establishing creditworthiness.
CAN HELP WITH BUSINESS ACQUISITION
Businesses that are just starting might fail to land big projects because they
have no legacy to back them. Companies often get cold feet about working with
such individuals or businesses. However, with an SBLC, they have a solid backing
of a reputed financial institution and hence can successfully compete for
prestigious contracts and big-ticket projects.
WHAT IS THE DIFFERENCE BETWEEN LC, SBLC, AND BANK GUARANTEE?
The fundamental difference between a Letter of Credit and a standby letter of
credit is that the former can be encashed or discounted during a trade
transaction. While an SBLC is just a safety measure and is only encashed if any
of the parties fail to honor the agreement, one cannot get an SBLC discounted if
there is no default. Most trades are honored by all the parties without any
irregularities and hence the SBLC is discontinued once the trade takes place.
On the other hand, while a bank guarantee only protects the buyer against a
non-performing seller, SBLCs protect both the buyer and the seller -- depending
on the type of SBLC issued.
FAQS ON SBLC
1. IS SBLC SAFE?
Standby Letters of Credit are highly secure documents that guarantee the payment
for the goods in case the buyer defaults or is unable to pay as per the
agreement.
2. HOW DO YOU USE SBLC?
An SBLC is used as a safety mechanism in a trade to ensure that the agreement is
honored by both parties.
3. CAN SBLC BE CONFIRMED?
Yes, an SBLC can be confirmed just like a normal letter of credit.
4. CAN SBLC BE CANCELED?
The SBLC is an irrevocable document and hence it cannot be canceled without the
consent of all the parties involved.
5. CAN SBLC BE MONETIZED?
Yes, SBLC can be monetized.
6. CAN SBLC BE TRANSFERABLE?
An SBLC is transferable in that the beneficiary can sell or assign the rights to
the proceeds from the SBLC, but the beneficiary remains the only party who can
demand payment of the SBLC.
7. CAN SBLC BE DONE WITHOUT UPFRONT PAYMENT?
Many companies and service providers claim that they do provide SBLC without
upfront payment. However, experts call it a myth and say that there can be no
SBLC without any upfront payment since the risk is too high.
8. IS SBLC LEGAL IN INDIA?
Yes, SBLC is legal and fully operational in India when issued by banks certified
by the Reserve Bank of India.
9. CAN SBLC BE DISCOUNTED?
Yes, an SBLC can be discounted and is often considered a great investment
instrument.
> Also Read:
* What is a Back to Back Letter of Credit?
* Irrevocable Letter of Credit | What is it & How does it work
* LC at Sight | Meaning & Complete process
* Export Payment Terms | Listing Safest mode of Payments in International trade
* Everything about Working Capital Loans
* What is an Overdraft Facility, and how does it work?
SIDDHI PAREKH
FINANCE MANAGER AT DRIP CAPITAL
With over a decade of experience in the finance industry, Siddhi is an adept
finance manager with a Diploma in IFRS from ACCA UK.
Collateral-Free Factoring Solutions
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Table of Content
1. What does SBLC stand for?
2. What Is SBLC
3. Who can issue SBCL?
4. How to get SBLC?
5. Types of SBLC
6. How does an SBLC work?
7. How much does an SBLC cost?
8. Advantages of SBLC
9. What is the difference between LC, SBLC, and Bank guarantee?
10. FAQs on SBLC
Table of Content
1. What does SBLC stand for?
2. What Is SBLC
3. Who can issue SBCL?
4. How to get SBLC?
5. Types of SBLC
6. How does an SBLC work?
7. How much does an SBLC cost?
8. Advantages of SBLC
9. What is the difference between LC, SBLC, and Bank guarantee?
10. FAQs on SBLC
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