Last Updated on 10/06/2021 by Pardeep Garg
Standby letter of credit (SBLC) is a process involving monetizing of bank instruments such as BG’s, LC’s or SKR’s with an aim to fund projects. The method is on the rise. Lending from traditional institutions has been practiced widely in the past. At present, it has virtually come to a stand-still. Monetizing of instruments has almost replaced it for good reasons.
SBLC is very popular as it does not require any down payments, traditional credit requirements, or asset requirements usually associated with conventional method of lending or funding. However, the approval process isn’t easy. The requirements are strict and include a satisfactory compliance report related to laws of International Money and Homeland Security Laundering.
This kind of funding involves conversion of a secured instrument sponsored by cash, secured asset, secured account into legal tender. In most cases, the cash backed, or secured account or asset is interned in a trust or a different account wherein the holder is not able to recover additional funds according to the account agreement.
What is SBLC/SLOC (Stand by Letter Of Credit)?
SBLC or SLOC is a sort of payment guarantee issued by the bank on behalf of its client. It is used as a last payment resort if the client fails to fulfill a commitment made to the third party via contract. Standby Letter Of Credit (SBLC) is a form of good faith in business deals and transactions.
These work as proof of the buyer’s repayment ability and credibility. However, this is a sort of last resort, and ideally never gets used.
How does SBLC Work?
SBLCs can work as the following standbys respectively:
Performance Standby:
SBLC works as a backing to your commitment to pay money and other funds. An obligation is also included which requires the buyer to pay for the losses in case of a default.
Advance-Payment Standby
It supports the obligation of a buyer in case an advance payment has been done by the supplier to the buyer.
Bid-Bond or Tender-Bond Standby
The SBLC works as a bid-bond as it backs an obligation to the buyer wherein they have to execute a contract if they are awarded a bid.
Counter Standby
SBLC works as a counter standby since it backs the issuance of a separate standby letter of credit or some other undertaking by the supplier of this counter standby.
Financial Standby
This supports the obligation of the buyer to pay funds. It can include any instrument that evidences an obligation to repay borrowed money.
Insurance Standby
SBLC works as an insurance standby as it supports the insurance obligation of the applicant.
Commercial Standby
It works as a Commercial Standby as it supports the buyer’s commitment to pay for goods/services if other payment methods don’t work.
Direct-Pay Standby
This is the primary method of payment which might or might not be linked to default in terms of performance or payment.
Why Monetize?
In the past, hospitality financing was considered a very monotonous and challenging industry. However, the process was attainable. However, this is not the case today. Hospitality financing has become almost impossible for those looking for remodeling, new purchases, construction, or refinancing.
In case, you own a hospitality property, there are increased chances of funding approval. However, this depends on performance through a period of 3-5 years. Since there are no performance requisites in case of projects related to hospitality, SBLC funding or instrument monetizing is the solution. Here, the performance is purely based on instrument guarantee than the guarantee of property.
It also stands correct for cases where residential developments halted in the middle of construction due to failure of construction on credit lines arranged earlier. Commercial developments can also benefit from this funding method because no “anchor” or tenant rolls are required. Financing of alternative energy project is specifically feasible for bank instrument monetization or SBLC funding. Monetizing may also be a feasible solution to community economic expansion, development of housing and employment and debt consolidation for organizations.
STEP BY STEP PROCEDURE FOR OBTAINING BG/ SBLC
- The beneficiary needs to submit a signed official Letter Of Interest (LOI) for applying to SBLC/BG along with the documents required.
- After a thorough and extensive review of the applicant/beneficiary followed by the Provider, the applicant/ beneficiary will be given the Deed of Agreement (DOA) Format that lists the Terms and Conditions of the Contract, approved contract amount (Face Value), schedule, price, etc.
- The beneficiary/applicant needs to fill in the DOA.
- After internal evaluation and scrutiny of the filled DOA and after being satisfied with it, the DOA shall be signed by the Provider and the Bank, and then returned to either the applicant/beneficiary or to their bank directly.
- A draft of the SBLC is then prepared by the provider.
- The client then needs to approve the draft and then sign a contract agreeing to the terms and conditions of issuance and issuance charges as negotiated.
- The client then makes payment of charges as agreed before.
- The SBLC draft is then uploaded to the SWIFT system and a copy is provided to the applicant for final approval of the message.
- Then, the SWIFT is released upon approval and its copies are forwarded to the client via email or hard copy as required.
Difference between SBLC and LC
Letter of Credit (LC) is the guarantee of payment provided some specifications are met and some documentation is provided by the selling party. A Standby Letter of Credit is a type of LC. An SBLC is paid when certain conditions of a financial deal have not been fulfilled but LC is a broad category, which simply provides the guarantee of payment.
So, you can see that SBLC and LC might seem quite similar but there is a long list of differences between the two. Please, go through the same below:
| Serial No. | Features | SBLC | LC |
| 1. | Definition | A Standby Letter of Credit (SBLC/SLOC) is a secondary payment method where the bank will guarantee payment if the terms of the LC are fulfilled by a seller. This ensures a kind of additional safety for the seller. | A letter of credit (LC) is a guarantee given by the bank that the buyer will fulfill the payment contract. It states that the buyer is obliged to pay the seller and if unable to do so, then the bank will pay the seller. However, the funds shall be received from the buyer. |
| 2. | The requirement of features/ Clauses | An SBLC that might have specific clauses that the buyer must fulfill to be able to use this scheme. | A Letter of Credit (LC) does not have any specific clauses or features that the buyer needs to fulfill. |
| 3. | Need for collateral | A Standby Letter of Credit calls for an obligation for the bank, and so, the bank will need collateral in the form of security. | While issuing a Letter of Credit, the bank analyses the buyer’s credibility and credit score. |
| 4. | Goal | A Standby Letter of Credit is considered to be a secondary payment instrument. | The Letter of Credit is a primary instrument of payment. |
| 5. | Time-period | A Standby Letter of Credit is a long-term instrument. It is generally valid for 1 year or so. | LC is a short-term instrument. It is valid for 90 days. |
| 6. | Purpose | The letter of credit is used to provide security for certain transactions. For example, a sale agreement. | A standby letter of credit is usually used for providing security for a long-term obligation. For example, a long-term construction project. |
| 7. | Location/ Geographical Scope | SBLC is used both in international and domestic transactions. | A letter of credit is usually utilized for international transactions wherein the buyer becomes the importer and the seller the exporter. |
| 8. | Cost | An SBLC is far more expensive than a usual LC. | The fees of an LC range from 0.75% to 1.50% of the covered amount. Also, the bank can charge anywhere from 1% to 10% to cover the same amount under a standby LC. |
How can you apply for a Standby Letter of Credit?
SLOC/ SBLC is a sort of insurance and so collateral might be needed by the bank for protection in case of default. This collateral could be with cash or assets as property. The level of collateral needed by the bank will depend on the risk involved, business strength, and the size of the SBLC.
Many other aspects are also considered while someone applies for an SBLC/SLOC, but, the main part is that the amount guaranteed gets repaid. Hence, it is an insurance mechanism for the company that is being contracted with.
Other standard due diligence questions are also asked, as well as information requests about the assets of the business and the owners. Some documentation is needed to be submitted which are reviewed by the bank.
After the letter has been provided, a fee is then payable by the business owner for every year that the Standby Letter of Credit remains outstanding.
What are the fees for Standby Letters of Credit?
SBLC/ SLOC has a standard fee between 1 to 10% of the SBLC value. If the business meets the contractual obligations before the due date, SBLC can be ended with zero further charges.
Conclusion
Hence, you might have understood by now that we can easily monetize SBLC or lend certain credible bank instruments issued via rated banks and use the same for project funding. You can also move the SBLC into several trading platforms quickly while incorporating them into financing various development projects. This way you will be able to monetize SBLCs for cash and for raising a credit line, for buy/sell platform entry, or both. We have tried our best to incorporate the details about SBLC in this article.
