A standby letter of credit, abbreviated as SBLC, refers to a legal document where a bank guarantees the payment of a specific amount of money to a seller if the buyer defaults on the agreement. An SBLC acts as a safety net for the payment of a shipment of physical goods or completed service to the seller, in the event something unforeseen prevents the buyer from making the scheduled payments to the seller. In such a case, the SBLC ensures the required payments are made to the seller after fulfillment of the required obligations.

The process of obtaining an SBLC is similar to a loan application process. The process starts when the buyer applies for an SBLC at a commercial bank. The bank will perform its due diligence on the buyer to assess its creditworthiness, based on past credit history and the most recent credit report. If the buyer’s creditworthiness is in question, the bank may require the buyer to provide an asset or the funds on deposit as collateral before approval.

The level of collateral will depend on the risk involved, the strength of the business, and the amount secured by the SBLC. The buyer will also be required to furnish the bank with information about the seller, shipping documents required for payment, the beneficiary’s bank, and the period when the SBLC is valid.

After review of the documentation, the commercial bank will provide an SBLC to the buyer. The bank will charge a service fee of 1% to 10% for each year when the financial instrument remains valid. If the buyer meets its obligations in the contract before the due date, the bank will terminate the SBLC without a further charge to the buyer.

If the buyer fails to meet the terms of the contract due to various reasons, such as bankruptcy, cash flow crunch, dishonesty, etc., the seller is required to present all the required documentation listed in the SBLC to the buyer’s bank within a specified period, and the bank will make the payment due to the seller’s bank.