What Is a standby letter of credit (SLOC)?
A standby letter ofcredit (SLOC) is a legal document that guarantees the obligation of a bank to pay a seller if the buyer or the consumer of the bank defaults on the contract. A standby letter of credit helps to promote foreign trade between companies that have different laws and regulations and do not know each other. Although the buyer is sure to receive the goods and the seller is sure to receive payment, a standby letter of credit does not guarantee that the buyer will be pleased with the goods. SBLC may also be abbreviated as a standby letter of credit. Merchant Credit and Guarantee Corporation Limited (MCG) facilitates with standby letter of credit.
How a Standby Letter of
Credit Works?
Very frequently, an
organisation needs a Standby Letter of Credit to assist it in securing a
contract. The deal is a "standby" arrangement and only in a
worst-case situation would the bank have to pay. Although the SBLC guarantees a
seller's payment, the arrangement must be followed precisely. For instance, a
shipping delay or a misspelling of the name of a business could lead to the
bank refusing to make the payment.
Two
major forms of standby credit letters exist:
·
A
financial standby letter of credit guarantees payment, as
defined by an arrangement, for goods or services. For example, an oil refining
company might arrange for such a letter to convince a crude oil seller that it
can pay for a huge supply of crude oil.
·
The less
popular output standby letter
of credit ensures
that the client can complete the project specified in the contract. In the case
that its client fails to complete the project, the bank decides to compensate
the third party.
The process for
receiving a standby
letter of credit is similar
to a loan application. Only after determining the applicant's creditworthiness
does the bank issue it.
In the worst-case
scenario, the bank issuing the standby
letter of creditwould meet
the obligations of its client if a corporation goes into bankruptcy or ceases
operations. For each year that the letter is valid, the client pays a fee. The
fee is usually 1 percent to 10 percent per year of the overall responsibility.
A Stand by Letter of Credit benefits
The standby
letter of credit is also
used in foreign trade contracts, which appear to require a big money investment
and have added risks.
The biggest gain for the organisation that is faced
with a standby letter of credit is the possible ease of getting out of the
worst-case situation. If an agreement requires payment within 30 days of
delivery and the payment is not made, the seller can send the standby letter of credit for payment to the buyer's bank. The seller is
thus, sure to be paid. Another benefit for the seller is that the SBLC
eliminates the possibility that the buyer changes or cancels the production
order.
The SBLC helps to ensure that the goods or services
outlined in the document are purchased by the customer. For instance, if a
contract needs a building to be constructed and the contractor fails to
perform, the customer presents the standby letter of credit to the bank to be made whole. Another gain is that
a buyer has an enhanced certainty that the goods will be delivered by the
seller while participating in global trade.
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