Letter of Credit

There are two types of bank guarantees:

1. standby letter of credit

It is a guarantee of payment issued by a bank/FI on behalf of a client that is used as payment in case of default by the applicant.

Standby Letters of Credit are issued for use in a wide variety of commercial and financial operations. Standby letters of credit are very much alike documentary letters of credit, their main difference is that unlike DLC’s, they only become operative in case the applicant defaults, then the beneficiary in whose favor the SBLC was issued, can draw on the SBLC and demand payment

Historically, Standby letters of credit were developed because the US regulator legally limited US bank’s authority to issue guarantees.

SBLC’s are very similar to demand guarantees, which also require that the presentation of stipulated documents be compliant with the terms and conditions of the guarantee. SBLC’s and guarantees are different in terms of protection, they both serve the primary purpose of making sure that sellers get paid, but while a standby letter of credit protects the seller, a bank guarantee protects both sides, since it also protects the buyer in case the supplier never ships the goods or ships them in a damaged condition.

Standby letters of credit are a very flexible tool, making them a suitable product for securing a wide range of payment scenarios.

A breakdown of SBLC types is provided below:

• A performance standby – backs a commitment to perform other than to pay money/funds and includes an obligation to pay for loses occurring from a default of the buyer in the process of completing an underlying transaction.
• An advance-payment standby – supports an obligation to account for an advance payment made by the supplier to the buyer.
• A bid-bond or tender-bond standby – backs an obligation of the buyer to execute a contract if the buyer is awarded a bid.
• A counter standby – backs the issuance of another, separate standby letter of credit or other undertaking by the supplier of the counter standby.
• A financial standby – supports an obligation to pay funds, including any instrument evidencing an obligation to repay borrowed money.
• An insurance standby – supports an insurance obligation of the applicant.
• A commercial standby – backs the commitment of a buyer to pay for goods or services in the event of non-payment by other methods.
• A direct-pay standby – intended to be the primary method of payment. It may or may not be linked to a default in performance or payment.

2. the documentary letter of credit

The Documentary Letter of Credit is mostly used for international transactions under which both the buyer and supplier operate from separate countries and build a relationship. The letter has a condition stating that the compliant presentation should be under it.

The Documentary Letter of Credit allows the recipients to receive the credits crucial for financing a project. This makes it a very important financial instrument, especially for short-term needs. For settling the due amount, the recipients are hopeful of getting enough returns in the stated time frame. A Documentary Letter of Credit consists of all the information like the expiry information, the date and time of the letter which is required by the beneficiary on presentation. The beneficiary gets the compliant presentation which is a guarantee by the Documentary Letter of Credit for getting paid. Meeting the delivery conditions is the prime condition that needs to be met.