Standby Letter of Credit – Definition

Cite this article as:"Standby Letter of Credit – Definition," in The Business Professor, updated April 23, 2019, last accessed October 20, 2020, https://thebusinessprofessor.com/lesson/standby-letter-of-credit-definition/.

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Standby Letter of Credit Definition

The legal document that guarantees that the lender will pay the sum agreed upon if the borrower fails to fulfil this obligation to the creditor is called a ‘Standby Letter of Credit’. SBLCs, or SLOCs, or simply LOCs, are issued in good faith to stand in as debt repayment guarantee and specify the legal responsibilities of all parties concerned. Banks or underwriting firms issuing the LOC ensure the credibility of firms or entities borrowing the money. The borrower’s bank is notified of this letter once issued.

A Little More on What is a Standby Letters of Credit

An SLOC stands in as a guarantee that a firm or individual is capable of repaying the borrowed money in the eventuality of the firm folding and ceasing operations. SLOCs are especially useful in international trade treaties as the risks involved with dealing in large sums are considerably higher, especially in light of diverse national laws.

Small and medium businesses with few options of raising capital for growth can fall back on an SLOC to borrow money or seek investments from individuals. Defaulting on these loans kicks the SLOC into operation and the underwriting bank provides the security of loans being repaid.

Obtaining a Standby Letter of Credit

Individuals and firms seeking an SLOC have to write to the bank requesting the same, in addition to declaring any assets, properties, or shares, as collateral in case of defaulting on the loan. The bank takes up to a week to process the request, assess the collateral value, and issue the Standby Letter of Credit. A fee of up to 10% is paid per year on the total value of the amount the letter guarantees. Clients are free to cancel a SLOC anytime without prior notice to the bank.

An Example of a Standby Letter of Credit

In international trade, buyers and sellers obtain Financial SLOCs from their respective banks before engaging in trade. Suppose a buyer is delivered goods but defaults on payment to the seller, the seller will wait until a specified period before approaching the buyer’s bank with the SLOC to get its payment for goods delivered.

References for Standby Letter of Credit

Academic Research on  Standby Letter of Credit

The No-Guaranty Rule and the Standby Letter of Credit Controversy, Lord, R. A. (1979). Banking lJ, 96, 46. This paper sheds light on the ‘No Guarantee’ clause included in SLOCs and the resulting controversies.

Enjoining the International Standby Letter of Credit: The Iranian Letter of Credit Cases, Getz, H. A. (1980). Harv. Int’l. LJ, 21, 189. This paper sheds light on SLOCs in international trade with Iran.

The Standby Letter of Credit Debate-The Case for Congressional Resolution, Katskee, M. R. (1975). Banking LJ, 92, 697. This paper examines the legislative issues influencing the debate on SLOCs.

The Standby Letter of Credit Debate, Harfield, H. (1977). Banking LJ, 94, 293. This paper presents a critical take on SLOCs and presents theories in favour of as well as against the issue.

Third-party certification in new issues of corporate tax-exempt bonds: standby letter of credit and bond rating interaction, Stover, R. D. (1996). Financial Management, 62-70. This paper examines the roles of various institutions involved in the issuance of SLOCs, and their interaction with bonds ratings.

Analyzing Bank Drafted Standby Letter of Credit Rules, The International Standby Practice (ISP98), Dolan, J. F. (1999). Wayne L. Rev., 45, 1865. This paper analyses the drafting of SLOCs by banks, the procedure, rules, and practices, in international trade.

From the Bankruptcy Courts: Release of Standby Letter of Credit as a Defense to a Preference Action, Weintraub, B., & Resnick, A. N. (1988). Uniform Commercial Code Law Journal, 21, 183. This paper examines a legal case around a SLOC and its implications.

The Standby Letter of Credit: What it is and how to use it, Banks, J. L. (1984). Mont. L. Rev., 45, 71. This paper provides an in-depth explanation of SLOCs, their enforcement, uses, and more.

The Domestic Standby Letter of Credit Desk Book for Business Professionals, Bankers and Lawyers, Dolan, J. (2016). This chapter makes the case for a SLOC and its various useful applications in business.

The Standby Letter of Credit and the Unsecured or Underliquidated Damages Clause, Browne, A. P. (1988). U. Bridgeport L. Rev., 9, 241. This paper sheds light on the enforceable clauses in a SLOC and provisions included to repay default amounts.

Documentary and Security Characteristics of Standby Letter of Credit in International Trade Law, Fallah, M. (2013). Comparative Law Researches, 17(2), 143-166. This paper focuses on the impact of SLOCs in international trade, characteristics, practices, and the legalese surrounding it.

Standby Letter of Credit is Not a Deposit, Rendell, R. (1986). Int’l Fin. L. Rev., 5, 11. This paper sheds light on the differences between a SLOC and bank deposits.

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