The What and How of SBLCs
A Standby Letter of Credit (SBLC) is a financial instrument issued by a bank based on instructions from a client, serving as both a means of payment and a guarantee. SBLC funding is facilitated by the issuing bank if the client is deemed creditworthy, and the bank may issue the SBLC on margin. Alternatively, if the client’s creditworthiness is uncertain, the bank will require adequate collateral before issuing the SBLC.
SBLCs are widely used in Switzerland and globally, particularly in the United States, where Bank Guarantees are not utilized, and SBLCs exclusively serve this purpose. The primary function of an SBLC is to secure trade transactions, both domestically and internationally, and it can also be employed for monetization purposes, as detailed below.
Standby Letter of Credit as a Payment Mechanism: In trade deals, particularly when the seller suspects challenges in receiving payment from the buyer, an SBLC acts as a payment of last resort. If the seller questions the buyer’s creditworthiness, they request the issuance of an SBLC in their favor. The buyer instructs their bank to open the SBLC, and upon shipment of the goods, if the buyer pays, the SBLC is canceled. If payment is not received, the seller can claim the amount against the SBLC, and the issuing bank pays the seller, seeking reimbursement from the buyer.
Standby Letter of Credit as a Payment Guarantee or SBLC Monetization: When an SBLC is monetized, it functions as a payment guarantee, resembling the terms of a Demand Bank Guarantee. Both instruments adhere to the ICC Uniform Rules for Demand Guarantees (URDG 758) and are payable on the first demand. Companies seeking loans or lines of credit can opt for an SBLC lease, obtaining it from an SBLC provider. The lessee signs a Collateral Transfer Agreement with the provider, leasing the SBLC for a specified period, usually one year. A Collateral Transfer Fee is paid to the provider, representing the leasing fee. Subsequently, the SBLC can be presented to the lessee’s bank as collateral for a line of credit or loan.