Standby letter of credit – What is it, definition and concept

The standby letter of credit is a type of letter of credit that serves as a guarantee to the seller in a commercial agreement.

In this sense, it is not a means of payment directly, but rather it is a guarantee of payment against non-payment by the importer.

When this instrument is used, the initial treatment is that once the conditions of the agreement have been fulfilled, the importer or buyer makes the payment for the merchandise. However, if there is a setback to fulfill the commitment, the issuing bank assumes to make the payment on behalf of its client.

In this way, the exporter is covered from the possibility of non-payment. Likewise, the importer can agree with the bank on a more flexible form of payment.

Characteristics of standby letter of credit

The standby letter of credit allows the exporter or seller to have a guarantee in their commercial operations. This, in case the importer or buyer does not comply with the obligations acquired in the commercial agreement. Therefore, it does not constitute a means of payment.

The obligations included in an agreement with this type of letter of credit can be commercial, financial or services. On the other hand, the entity that regulates the issuance of this instrument is the International Chamber of Commerce.

Differences between the common letter of credit and the stand by

The fundamental difference between the two letters of credit is that the common one acts as a means of payment and the standby one acts as a guarantee. In the first, once the parties have complied with the agreement, the issuing bank takes charge of the payment. In the second, the letter of credit is executed only if the importer or buyer fails to fulfill his obligations and the seller or exporter complied.

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Also, in the common or normal, the parties are obliged to deliver more rigid documentation to enforce the agreement. Meanwhile, the standby is more flexible since it only represents a guarantee in case of non-compliance.

This occurs because there is a trust relationship between the buyer and the issuing bank. In this sense, in operational terms, the standby is more convenient for the seller because he only has to present documentation in case of non-compliance.

General considerations of the standby letter of credit

The purpose of this instrument is to serve as a guarantee in a commercial agreement. Therefore, there are aspects to be taken into account by the seller such as the amount of coverage and expiration date. First, the seller makes sure that he receives full payment for his products or services.

Second, the due date guarantees a deadline to receive the corresponding payment, either by the buyer or the issuing bank. Automated collection is an important advantage despite the violation of the contract.

Finally, it is necessary to clarify the documents necessary to enforce the guarantee contract. In general, a default letter and the necessary documents are needed to prove that the seller complied with what was agreed.

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