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The main difference between a Standby Letter of Credit and Letter of Credit is that Standby letter of credit are secondary payment options which means they act as a guarantee and will be utilized in case another primary payment mechanism does not work. Whereas Letter of Credit is a primary payment method in international sales.
A Standby Letter of Credit (SLC) is a document issued by a bank that guarantees payment to the beneficiary in the event the applicant fails to fulfill an obligation (i.e. contract performance). The SLC will stipulate the requirements for making a claim against the SLC. These requirements are negotiable and must be agreed upon by both parties. International rules exist through the International Chamber of Commerce (ICC) that govern how banks handle SLCs. A Performance Bond is a guarantee issued by a Surety (insurance co.) that stipulates the Surety will pay for the costs of completion a contract in the event of the applicant's non-performance. The terms of a performance bond are typically predetermined by the Surety. Performance bonds are used predominantly in North America and SLCs tend to be more common in international transactions. The costs of a SLC and a Performance Bond vary, with a SLC usually more expensive. A SLC also tends to be more risky for the applicant, as it leaves one open to a risk referred to as "Wrongful Call"; whereby the beneficiary requests payment from the bank with the appropriate documents containing the necessary wording without a valid basis for the claim. Banks will NOT make any attempts to confirm the veracity of a claim. If documents are in order the bank will pay. The bank will expect the applicant to pay them and the applicant needs to recover the monies from the beneficiary. Banks refuse to become involved in contractual disputes. A Performance Bond prevents this type of risk as an insurance co. will not pay without validating the claim, and often defending against the claim. Obtaining payment often involves legal action. This is the downside for a beneficiary.
A standby LC is one you don't expect to use - it's on standby. Otherwise they are the same. Sometimes people use the term LC to mean standby LC.
The ‘Letter of Credit’ and the ‘StandBy Letter of Credit’ are two legal bank documents that are used by international traders. Both these letters are used to ensure the financial safety between the supplier and their buyers. And, SBLC is a type of LC that is used when there is a contingent upon the performance of the buyer and this letter is available with the seller to prove the buyer’s non-performance during the sale.
Based on this, there are two types of LCs being issued, they are:
· Letter of Credit (LC) and
· Stand By Letter of Credit (SBLC)
Now, the LC depends on the performance by the supplier, whereas SBLC depends on the on the non-performance or default on the part of the buyer.
Simple meaning,
DLC: It provides assurance to the beneficiary/exporter by the advising bank on behalf of issuing bank that buyer/Importer will make payment..
SBLC: Guarantee by the issuing bank, if buyer failed to complete the commentment "Payment of last resort" bank pay on behalf of it to the supplier/beneficiary.
Key difference: The ‘Letter of Credit’ and the ‘StandBy Letter of Credit’ are two legal bank documents that are used by international traders. Both these letters are used to ensure the financial safety between the supplier and their buyers. And, SBLC is a type of LC that is used when there is a contingent upon the performance of the buyer and this letter is available with the seller to prove the buyer’s non-performance during the sale.
LC and SLBC are the two financial instruments that are meant to safeguard the financial interests of the international traders i.e. buyers and sellers. It simply means that both these terms are widely useful while making transaction between the two trading parties. These help in giving financial security to both the parties. Also, these contracts are produced in good faith and in both the cases the fund gets mobilized.
During a transaction, the buyer wants an assurance of receiving his product or merchandise on time, and the seller wants his security of being paid on time at the completion of the job. Here, a letter of credit is issued, for it is an assurance or a type of guarantee that the seller will receive his correct payments in time by the clients. The LC solves both the issues by bringing in the buyer's and seller's banks into the transaction.
The issuing bank of the buyer, then, opens a LC in the favor of the seller and states that seller will be paid and that he or she will not suffer any damages or losses because of the non-payment of the buyer. Though, the money transfer to the seller will only be initiated after all the conditions or documents of the contract are completed. However, the bank also safeguards the interest of the buyer by not paying the supplier until it receives a confirmation from the supplier that the goods have been shipped.
Based on this, there are two types of LCs being issued, they are:
Now, the DLC depends on the performance by the supplier, whereas SBLC depends on the on the non-performance or default on the part of the buyer.
A SBLC works on the same principle as a documentary letter of credit but with different objectives and required documents. The essence of SBLC is that the issuing bank will perform in the case of non performance or default by the buyer.
The purpose of this letter is to establish a bank guarantee for the deal or transaction with a third party. For example, if an individual wishes to take a loan, but does not have a sufficient credit standing, the bank may then ask for a guarantee from another party (third party), and this is done in the form of a standby letter of credit that is issued by another bank. However, the said individual would then have to produce certain documents or evidence to support the non-performance of the buyer to obtain the payment through the SBLC. The bank is obligated to make payment if the documents presented comply with the terms of contract. Though, the SBLC are considered very versatile and can be used with modifications to suit the interests and requirements of the buyers and sellers.
• Letter of Credit is a financial instrument that ensures timely and correct payments to suppliers from their international buyers
• SBLC is a type of LC that is contingent upon non performance or default by the buyer and is available to the beneficiary (supplier) when he proves this non performance of the buyer to the issuing bank.
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