Finnex Singapore

Understanding the Key Differences & Utility between LC and SBLC

Earlier in our article on Trade Finance, we have mentioned the different types of letter of credit. Here, you will get to understand them deeper and the differences and key usage of between LC and SBLC.

Both the regular letter of credit (LC) and standby letter of credit (SBLC) are payment instruments used in international trade.

A letter of credit is a promise from the bank that the buyer i.e. importer will fulfill his payment obligation and pay the full invoice amount on time. The role of the issuing bank is to make sure that the buyer pays. In case the buyer is unable to fulfill his obligation, the bank will pay to the seller i.e. the exporter, but the funds come from the buyer.

Meaning

A letter of credit is a promise from the bank that the buyer i.e. importer will fulfill his payment obligation and pay the full invoice amount on time. The role of the issuing bank is to make sure that the buyer pays. In case the buyer is unable to fulfill his obligation, the bank will pay to the seller i.e. the exporter, but the funds come from the buyer.

On the other hand, a standby letter of credit (SBLC) is a secondary payment method where the bank guarantees the payment when terms of the letter of credit are fulfilled by the seller. It is a kind of additional safety net for the seller. The buyer may not pay the seller due to multiple reasons such as cash flow crunch, dishonesty, bankruptcy, etc. But as long as the seller meets the requirement of a standby letter of credit (SBLC), the bank will pay.

Features within the Instrument

A letter of credit does not have any specific features that the buyer must adhere to for the completion of a transaction. It does have basic requirements such as documentation, packing, etc. But all in all, it’s a plain vanilla payment instrument.

A standby letter of credit may have specific clauses that the buyer must fulfill so he can use this instrument.

The Requirement of Issuing Bank

When issuing a letter of credit, the bank checks the buyer’s credibility and credit score. Furthermore, it is usually the case that a buyer asks his banker for a letter of credit, i.e. the buyer is usually dealing with the said bank for a long time. So, the letters of credit are usually unsecured.

Conversely, a standby letter of credit creates an obligation for the bank, therefore the bank will require collateral in the form of security to issue a standby letter of credit.

Goal

The letter of credit is a primary instrument of payment, so the goal is to use the letter of credit to complete the transaction.

In contrast, a standby letter of credit is a secondary instrument of payment. If a seller is paid by a standby letter of credit, it means that something went wrong. The goal here for all the parties involved is to avoid using a standby letter of payment.

Time Period

A letter of credit is a short-term instrument, where the expiry is upon good received by buyer (LC at sight) or usually 90 days (usance LC).

A standby letter of credit is a long-term instrument, in which the validity is usually one year or so stated within the terms of the instrument.

Purpose

A letter of credit is used to provide security for a transaction such as a sale agreement.

A standby letter of credit is often used to provide security for a long-term obligation such as a long-term construction project.

Geographical Scope

A letter of credit is usually used in an international transaction where the buyer is the importer and the seller is the exporter.

A standby letter of credit is used in an international transaction but it is also frequently used in domestic transactions as well. Its scope is not limited to any geographical area.

Cost

Apart from the standard bank charges, a standby letter of credit is more expensive than a regular letter of credit. While the fees of a regular letter of credit range around 0.125% of the amount covered, a bank may charge anywhere from that to 5% to cover the same amount under a standby letter of credit.

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