A Standby Letter of Credit (SBLC) is a legal document that guarantees a bank’s commitment of payment to a seller if the buyer–or the bank’s client–defaults on the agreement. A standby letter of credit helps facilitate international trade between companies that don’t know each other and have different laws and regulations. Although the buyer is certain to receive the goods and the seller is certain to receive payment, an SBLC doesn’t guarantee the buyer will be happy with the goods. A standby letter of credit can also be abbreviated SBLC.

How a Standby Letter of Credit Works

An SBLC is most often sought by a business to help it obtain Credit. The credit is a “standby” agreement because the bank will have to pay only in a worst-case scenario. Although an SBLC guarantees payment to a seller, the agreement must be followed exactly. For example, a delay in shipping or a misspelling of a company’s name can lead to the bank refusing to make the payment.

There are two main types of Standby Letter of Credit:

A financial SBLC guarantees payment for goods or services as specified by an agreement. An oil refining company, for example, might arrange for such a letter to reassure a seller of crude oil that it can pay for a huge delivery of crude oil.

The performance SBLC, which is less common, guarantees that the client will complete the project outlined in a contract. The bank agrees to reimburse the third party if its client fails to complete the project.

Advantages of a Standby Letter of Credit:

The SBLC is often seen in contracts involving international trade, which tend to involve a large commitment of money and have added risks.

For the business that is presented with an SBLC, the greatest advantage is the potential ease of getting out of that worst-case scenario. If an agreement calls for payment within 30 days of delivery and the payment is not made, the seller can present the SBLC to the buyer’s bank for payment. Thus, the seller is guaranteed to be paid. Another advantage for the seller is that the SBLC reduces the risk of the production order being changed or cancelled by the buyer.

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