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Types of Letter of Credit: Standby Letter of Credit (SBLC), and Irrevocable Letter of Credit

Although a Letter of Credit, Standby Letter of Credit, and Irrevocable Letter of Credit all sound very similar, are they really the same? These bank letters have been used for many years in commercial trade transactions. There are two types of bank letters of credit: Documentary Letters of Credit, also known as Commercial Letters of Credit, and Standby Letters of Credit. They share a common name, and both letters are meant to assure parties involved in commercial transactions that their contractual obligations will be honored. However, they have fundamental differences and serve distinct purposes.

A. Difference between Letter of Credit and Standby Letter of Credit

1. What is a Letter of Credit and how does it work?

A Letter of Credit (also known as Documentary Credit) is a primary payment method that the buyer gives to the seller for trading purposes. This letter is basically an assurance from the buyer's bank (also known by the issuing bank/remitting bank), that they will pay the entire amount due under the letter.

The seller must present certain shipping documents to the issuing bank. These documents include a clean bill or other shipping documents, such as a packing list. The seller's bank, also known as the collecting or advising bank, will pay the buyer the funds at the sight of a conforming presentation according to the terms and conditions.

Documentary letters of Lease Sblc credit are irrevocable and signify that the issuing bank will honor any complying obligation. They are used primarily as a payment method for international trades. They are used to encourage trust in transactions, particularly for international deals that involve factors such as distance, knowledge, and differences between the legal systems of the parties.

2. What is a Standby Letter of Credit?

A Standby Letter of Credit, on the other hand is known as "SBLC" This is basically an assurance by the bank that the purchaser will pay the full amount as per its terms. It acts as a secondary payment method and a guarantee for transactions.

This is when the bank guarantees payment to the purchaser if the terms of the letter have been fulfilled by the seller. The bank is responsible for ensuring that the purchaser pays. The seller can draw on the SBLC to pay the buyer if the purchaser fails to pay.

An SBLC is a sign that the buyer has good faith. It provides proof of credit quality and sincerity in making payments.

3. What is an Irrevocable Credit Letter?

An irrevocable letter of credit simply means that the buyer cannot cancel the credit once it has been issued. This is because all parties to the Letter of Credit have agreed. Letters of Credit are usually irrevocable and give the Seller the assurance that the letter will be paid upon shipment. This allows the Seller to manage its credit risk.

B. Difference between Standby Letter of Credit vs. Demand Guarantee

SBLC is similar in concept to a demand guarantee. The seller can draw on the SBLC if the buyer fails to pay. The bank's liability is therefore secondary. To support non-monetary obligations in international trade, such as those of contractors under construction contracts, demand guarantees are used. They are not used by the buyer to guarantee non-payment obligations. Instead, they are preferred to protect against delivery risks.

Because of the sensitive nature of the term "guarantee", SBLC is often used in the US instead of demand guarantees. SBLC is a financial tool that can be used to support both financial and non-financial transactions. They can also be used to issue securities in order to obtain a higher credit rating.

SBLC is an extra safety net for sellers because it guarantees that the bank will pay even if the buyer is unable. This means that even if the original purchaser is not able to pay the seller (e.g. Because of cash flow difficulties, bankruptcy, or fraud. An SBLC payment is, therefore, a last resort and should not be used.

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