Standby letter of credit (SBLC): how it works and when to use it

What is a standby letter of credit?

A standby letter of credit (SBLC or SLC) is a written undertaking by a bank (the issuer), given at the request of its customer (the applicant), to pay a beneficiary up to a stated amount when the beneficiary presents a demand and the documents required by the standby.

The difference with a commercial letter of credit lies in its purpose. A commercial LC is the normal way the seller gets paid. A standby is a back-up: it pays only if the applicant does not pay or does not perform. If the underlying contract goes as planned, the standby simply expires.

Like other independent undertakings, a standby is separate from the contract it supports. The issuer examines the documents presented, not whether the applicant actually defaulted. The instrument developed in the United States, where banks were historically restricted from issuing guarantees, and it is now used worldwide as a functional equivalent of a demand guarantee. The LC vs SBLC vs bank guarantee comparison sets the three side by side.

How is an SBLC drawn?

The standby states what the beneficiary must present. Typically:

• a signed demand for payment, stating the amount claimed;
• a statement that the applicant has failed to pay or perform under the identified contract;
• any additional documents required, for example a copy of an unpaid invoice or a notice of default sent to the applicant.

The demand is presented to the issuer, or to a confirmer if there is one, at the place and in the form (paper or electronic) stated, before expiry. Between banks, a demand may be sent by SWIFT MT765. The issuer checks the presentation on its face. Under ISP98, notice of dishonour must be given within a time that is not unreasonable: notice within three business days is deemed not unreasonable, and beyond seven business days it is deemed unreasonable.

Example (illustrative): a supplier in Germany sells components on 90-day open account terms to a manufacturer in Morocco. Instead of an LC for each shipment, the buyer’s bank issues a standby in the supplier’s favour for an agreed maximum amount, subject to ISP98. If an invoice remains unpaid at maturity, the supplier presents a demand, a statement of non-payment and a copy of the invoice, and is paid by the bank. If the buyer pays every invoice on time, the standby expires unused.

ISP98 or UCP 600: which rules apply to a standby?

A standby must state the rules it is subject to. ISP98 (International Standby Practices, ICC Publication No. 590) was drafted specifically for standbys and has applied since 1 January 1999. UCP 600 also covers standbys “to the extent applicable”, but it was written for commercial credits. Some standbys, especially outside the United States, are issued subject to URDG 758.

What is an SBLC used for?

• Payment (financial) standby: secures the applicant’s obligation to pay money, for example a supplier’s open-account sales or a lease.
• Performance standby: secures completion of a contract or delivery of goods or services.
• Advance payment standby: secures repayment of an advance if the supplier does not perform.
• Bid (tender) standby: secures a bidder’s commitment to sign the contract if awarded.
• Counter standby: supports a local guarantee or standby issued by another bank in the beneficiary’s country.
• Security for a credit facility: a standby issued in favour of a lender, which then extends a loan to the applicant or to a related company. This is the legitimate core behind the term “monetization”, explained in our SBLC monetization guide.

What should an SBLC’s wording and validity look like?

Most disputes over standbys come from wording. A complete text usually states:

• the issuer, applicant and beneficiary, with full names and addresses;
• the underlying contract or obligation being supported;
• the maximum amount, the currency and any reduction mechanism;
• the documents required for a drawing, worded so they can be produced by the beneficiary alone where that is the intention;
• whether partial and multiple drawings are allowed (ISP98 allows them unless the standby says otherwise);
• the place and form of presentation, and the expiry date;
• any automatic extension clause and the notice period for non-extension;
• the applicable rules (ISP98, UCP 600 or URDG 758) and, where relevant, the governing law and jurisdiction;
• who bears charges.

In the MT760, field 40C states the applicable rules. Amendments travel by MT767 and need the beneficiary’s consent to be binding on it.

A standby has an expiry date or an expiry event, chosen to cover the contract period plus a margin for presenting a demand. Many standbys covering ongoing obligations carry an automatic extension (often called “evergreen”) clause: the standby renews for successive periods unless the issuer gives notice of non-extension a stated number of days before expiry. Such notices often entitle the beneficiary to draw, so the clause needs careful drafting by both sides.

What drives the cost of an SBLC?

Banks usually quote a commission as a percentage per year or per quarter of the amount, plus fixed fees for issuance, amendment and any confirmation. The level depends on the applicant’s creditworthiness and existing relationship with the bank, the collateral or cash margin provided, the tenor, the amount, the country risk of the parties and the risk in the wording. No responsible party can quote a firm price before the bank has reviewed the applicant. See our guide to LC and SBLC costs for the components.

What an SBLC is not

An SBLC is not an asset that can be bought, rented or traded for profit. Banks issue standbys for their own customers, to secure a real obligation towards an identified beneficiary, after credit approval. Offers to “lease” an SBLC to an unrelated party, or to place one in a “trading programme” with guaranteed returns, are described by the US SEC as “prime bank” schemes. A free-format MT799 is not an SBLC either. Our guide to leased SBLCs and bank guarantees lists the red flags.

How Star Alliance helps with standby letters of credit

Star Alliance Consulting reviews the obligation the standby must secure, prepares the file and a proposed wording under the appropriate rules, and coordinates with the applicant, the beneficiary and the issuing institution. We do not issue, sell or lease instruments, and the decision to issue rests with the bank. Details are on our standby letters of credit page.

Frequently asked questions