GLOBAL SELLING BLOG

Standby Letter of Credit (SBLC): What is its role and how to obtain it?

Standby letter of credit assures exporters that the bank will pay for goods delivered if the customer (importer) fails to make payment on time. Learn more about its types and uses in this blog.

Any financial transaction is based on mutual trust between the involved parties. When it comes to international trade, exporter and importer land on a mutual understanding that the former will provide goods in discussed quality and quantity, and the latter will make payments as discussed. Sometimes, due to various reasons, the importer may not be able to make payments to the exporter, leading to a breach of trust and contract. Therefore, a mediating entity like a bank can help avoid disputes and ensure hassle-free import and export. This is where Standby Letter of Credit (SBLC) comes to the rescue by offering a backup payment plan.

What is a Standby Letter of Credit (SBLC)?

Standby letters of credit are used in open account trade (goods are shipped and delivered before payment is due), collections, and Documentary Credits (DCs). The bank offers a standby letter of credit on behalf of the importer to guarantee payment to the exporter, in case the importer defaults on the agreement.
SBLC ensures hassle-free trade between international companies that have different trade laws and regulations.

How does a standby letter of credit work?

Before the applicant (exporter) receives an SBLC, the bank verifies the creditworthiness of the applicant (importer) by conducting due diligence to know if the applicant is eligible to receive an SBLC or not. The applicant’s financial history, credit ratings and reports are evaluated to gain an insight into their past credit transactions. In some cases, the bank also asks for collateral¹. In some cases, the bank also asks for collateral. The level of collateral depends on the strength of the business, risks involved, and the amount secured by SBLC.

Benefits of using standby letter of credit (SBLC)

• If an agreement calls for payment within 30 days of delivery and the payment is not made, exporter can present the SBLC to the importer’s bank for payment. SBLC acts as guarantee of payment for the exporter.
• Another advantage is that the importer has an increased certainty that the goods will be delivered by the exporter.

Risks of a standby letter of credit

Some of the risks of an SBLC are bankruptcy and insufficient cash flows for the importer, which might prevent them from making payments to the exporter on time.

Types of standby letter of credit

Here are a few types of SBLC²:

Financial standby letter of credit

A Financial SBLC offers a payment guarantee to the exporter for goods within a stipulated time frame mentioned in the agreement with the importer.

Performance standby letter of credit

A performance SBLC guarantees project completion as per the contract. If the bank’s client (importer) fails to complete the project as per the set timeline, the bank reimburses their service receiver and levies penalties on the importer.

Advance payment standby letter of credit

An advance payment SBLC offers security if the importer fails to provide advance payment to the other party involved in the contract.

Insurance standby letter of credit

An insurance SBLC supports the applicant if they have committed to insurance but failed to make the payment.

Counter standby letter of credit

A counter SBLC is provided by a bank in one country to a bank in a different country and requests to issue a new SBLC for their local client.

Tender standby letter of credit

A tender SBLC protects the importer from failing to finish the project on time since they are awarded the tender or bid bond for the project.

Direct pay standby letter of credit

A direct pay SBLC covers the importer in case of financial instability.

What is SBLC used for?

When it comes to international trade, timely payments are paramount as they affect the trust between involved parties. The contract is in the ‘standby’ form, which means the bank only pays if the importer defaults on the payment and only specific conditions in the contract are met. For example, the bank is not liable to pay the exporter if there are shipping delays or inconsistencies in paperwork. SBLC holders use it to gain financial security if they fail to fulfil the terms of their contract with the seller.

Who can issue SBLC?

Any bank or non-banking financial companies can issue SBLC if they have validated the applicant’s creditworthiness based on their credit history and reports.

How to obtain an SBLC?

The process of acquiring SBLC is similar to obtaining a loan from a bank. Here are the steps involved:

Step 1

The importer submits an application for SBLC to a commercial bank or non-banking financial company if they have the provisions to provide SBLC.

Step 2

Once the application is submitted, the bank evaluates the importer’s creditworthiness by assessing credit history, reports and past transactions.

Step 3

If bank requires more information, it might ask for additional funds or assets to be secured as collateral before approving an SBLC. The importer must also present additional information such as shipping documents, beneficiary bank, the details of the exporter and the validity of the SBLC.

Step 4

Once the bank verifies the documents, it approves an SBLC to the importer. Banks usually charge 1% to 10% of trade value as their service fees each year of the tenure of the SBLC. If the obligations in the agreement are met before the validity, the bank terminates the SBLC and doesn’t charge fees.

Step 5

If the importer fails to make the payment, an exporter can present necessary documents mentioned in the agreement within the time limit and the bank will make the payment to the exporter.

International trades involves planning not just in logistics and production but also finances. With e-commerce exports, businesses receive support that can accelerate global expansion in an easy way.

Easy e-commerce exports with Amazon
Global Selling

Owing to access to technology, the internet has been the major driving force behind the evolution of international trade. E-commerce has eased the ability of businesses to import and export products around the world.

Indian exporters too are increasingly opting for e-commerce exports to sell internationally. Providing access to 18+ global marketplaces across the globe, Amazon Global Selling makes the export process easy and hassle-free. Whether you are a multi-city store, local seller, upcoming startup or a seasoned exporter, irrespective of your business size, you can export your products and establish your business on the world map. Warehousing, compliance, shipping, delivery and returns – Amazon Global Selling assists you in every step to help you run a successful export business.

More blogs on Letter of Credit

1. Letter of Credit at Sight: Meaning, process and its benefits

2. What is a Transferable Letter of Credit?

3. Irrevocable Letter of Credit: Meaning, process and benefits

4. Green Clause Letter of Credit: Definition, example and features

5. Documentary Letter of Credit: Overview and working

6. Revocable Letter of Credit: Everything you need to know about its uses

7. Red Clause Letter of Credit: Meaning, example and types

8. What is a Letter of Credit?

9. Usance Letter of Credit: Overview, meaning and process

10. Revolving Letter of Credit: Overview, meaning and process

11. Back to Back Letter of Credit: Overview, meaning and process

Frequently Asked Questions

Is SBLC safe?

SBLC is a highly secure document that ensures guaranteed payment to the exporter for goods when the importer fails to make the payment as per the agreement.

How do you use SBLC?

SBLC is used as a bridge of trust between the parties involved in trade.

Can SBLC be confirmed?

Yes, like other letters of credit, SBLC can also be confirmed.

Is SBLC legal in India?

Yes. SBLC is a legal and fully functional procedure in India. The banks certified by the Reserve Bank of India can issue an SBLC.

Who can issue a SBLC?

Any bank or non-banking financial company can issue SBLC if they have validated the applicant’s creditworthiness based on their credit history and reports⁵.

What are the essential fees for Standby Letters of Credit?

The fee for a standby letter of credit usually lies in the range of 1-10% of the SBLC value.

Published on October 20, 2022.

Sources:
1. https://www.nordea.com/en/doc/nordea-standby-letters-of-credit-fact-sheet-for-importers.pdf
2. https://corporatefinanceinstitute.com/resources/knowledge/credit/standby-letter-of-credit-sblc/
3. https://www.investopedia.com/terms/s/standbyletterofcredit.asp
4. https://www.letterofcredit.biz/index.php/2018/10/17/types-of-standby-letters-of-credit/
5. https://www.investopedia.com/terms/s/standbyletterofcredit.asp
6. https://www.emeriobanque.com/blogs/reasons-to-use-standby-letter-of-credit-in-international-transactions
7. https://www.tradefinanceglobal.com/letters-of-credit/standby-letter-of-credit-sblc/

What is an Importer of Record (IOR)?

Guide on how to export from India