A Standby Letter of Credit is a guarantee that is made by a bank on behalf of a client typically a buyer, which ensures payment will be made to the beneficiary, typically a seller if the client cannot fulfill the contractual obligations. A Standby Letter of Credit is also known as Non-Performing Letter of Credit.
A guarantee of payment issued by a bank on behalf of a client that is used as “payment of last resort” should the client fail to fulfil a contractual commitment with a third party. Standby letters of credit are created as a sign of good faith in business transactions, and are proof of a buyer’s credit quality and repayment abilities. The bank issuing the SBLC will perform brief underwriting duties to ensure the credit quality of the party seeking the SBLC, then send notification to the bank of the party requesting the SBLC (typically a seller or creditor).
A SBLC will typically be in force for about one year, allowing for enough time for payment to be made through standard contractual guidelines. SBLC’s are often used in international trade transactions, such as the purchase of goods from another country. The seller will ask for a SBLC, which can be cashed on demand if the buyer fails to make payment by the date specified in the contract. The letter can be canceled as soon as the terms of the contract have been met by the purchaser or borrower.