Standby Letter of Credit (SBLC) – Comprehensive Guide to Definition, Process, and Applications

Standby Letters of Credit (SBLC) are special, bank-issued legal instruments crucial in international trade, project finance, and other business transactions requiring strong payment guarantees In essence, an SBLC serves as a safety net: it obligates a bank to pay a beneficiary if the bank’s client (the applicant) fails to fulfill contractual obligations. This instrument has historically seen the most development and use in the United States, where for decades SBLCs have effectively replaced bank guarantees, as U.S. banks traditionally lacked authority to issue standard guarantees). In recent years, however, SBLCs have become a widespread practice globally as companies seek secure ways to mitigate risk in high-value deals.

Standby letters of credit offer a higher level of reliability compared to many traditional guarantee arrangements, which may rely on inconsistent national laws. For example, an SBLC can protect the owner of a large construction project if the contractor fails to perform, is delayed, or otherwise breaches the contract. Contractors might also utilize SBLCs to guard against non-performance by subcontractors. SBLCs find use in a wide array of scenarios: ensuring maintenance obligations, guaranteeing fulfillment of trade contracts (sometimes in addition to ordinary commercial letters of credit), facilitating joint ventures or securities issuance, reinsurance agreements, securing M&A transactions, and other operations where a robust financial assurance is needed.

Below, we provide a detailed, structured guide on SBLCs, including: their definition and legal context; how they work in practice (process flow and stakeholders); cost considerations; different types of letters of credit and where SBLCs fit in; risk and compliance considerations; use cases across industries; comparisons with other instruments like documentary credits and bank guarantees; the governing rules (ISP98, UCP 600, URDG 758); and practical guidance on leveraging SBLCs effectively. This comprehensive overview is intended for business professionals who require a clear and rigorous understanding of standby letters of credit.

What is a Standby Letter of Credit (SBLC)?

A Standby Letter of Credit (SBLC) is a bank’s commitment (obligation) to pay a specified amount to a beneficiary on demand if a client (the applicant) fails to meet some contractual duty. In other words, the issuing bank promises to pay the beneficiary within the agreed amount and time frame, provided the beneficiary presents documents that comply with the terms of the SBLC and indicate that the applicant has not fulfilled its obligations under the underlying contract. The SBLC thus acts as a form of guarantee of payment or performance, ensuring the beneficiary is protected from counterparty default.

It is important to note that an SBLC represents an obligation of the bank, not the applicant. Once the required documents are presented showing the applicant’s default (or other triggering event defined in the SBLC), the bank must pay the beneficiary. The bank will then seek reimbursement from its client (the applicant), but as far as the beneficiary is concerned, payment under an SBLC does not depend on the applicant’s ability or willingness to pay – it depends only on the presentation of conforming documents to the bank.

In practice, a standby letter of credit resembles a bank guarantee in function, and indeed SBLCs are often used in situations where a bank guarantee would otherwise be required. However, an SBLC is structured as a type of letter of credit and is generally governed by international rules (more on that below), which differentiates it from many bank guarantees that are subject to various local laws. An SBLC is also similar in concept to the better-known documentary (commercial) letter of credit (L/C), but with a key difference in purpose:

• A documentary L/C is typically intended to ensure payment for goods or services. The bank pays when the seller/exporter (beneficiary) performs and presents required shipping or performance documents. It is a payment mechanism used when the transaction goes right (payment is made against evidence of contract fulfillment).
• A standby L/C, on the other hand, is intended to serve as a back-up guarantee – the bank pays only if something goes wrong, e.g. the buyer/importer (applicant) fails to pay or perform. It is a security mechanism used when the transaction goes wrong (payment is made against evidence of default or non-performance).

Because of this, an SBLC cannot be used for routine financing of a contract in the way a documentary L/C is; instead, it “stands by” in case of a breach. If the primary obligations are duly fulfilled (the buyer pays on time, or the contractor performs properly), then the SBLC simply expires without being drawn. This gives the beneficiary assurance of payment or performance, while not necessarily being used unless needed – very much like a traditional guarantee.

Legal Context: SBLCs are usually issued subject to internationally recognized rules published by the International Chamber of Commerce (ICC). Most standby credits incorporate either the ICC’s Uniform Customs and Practice for Documentary Credits, Publication 600 (UCP 600) or the specialized International Standby Practices (ISP 98) as governing rules. These frameworks standardize the responsibilities of banks and the requirements for document handling. By using UCP 600 or ISP 98, banks and beneficiaries ensure the SBLC operates under a clear set of international guidelines rather than any one country’s laws. (By contrast, bank guarantees often rely on national law unless they explicitly adopt the ICC’s Uniform Rules for Demand Guarantees (URDG 758) or similar). We will discuss these rule sets later in detail.

An SBLC’s content is highly formalized, often sent as a SWIFT message between banks with designated fields for key terms (amount, expiry date, conditions, documents, etc.). In this respect, an SBLC’s format is more standardized – akin to a documentary credit – whereas ordinary guarantees may vary more in format and wording. This formal structure via SWIFT allows SBLCs to be efficiently communicated and confirmed worldwide through a secure banking network, providing confidence to all parties.

In summary, a standby letter of credit is a powerful instrument to mitigate risks such as non-payment, non-performance, or other contract breaches. It provides a financial safety net for transactions: the beneficiary gains a high level of security that funds will be received if the counterparty defaults, and the applicant enhances its credibility by backing its promises with a bank’s guarantee of payment. Both large corporations and small or medium enterprises (SMEs) can utilize SBLCs to safely engage in ventures (especially cross-border deals) that might otherwise be deemed too risky.

How Does a Standby Letter of Credit Work?

Mechanism Overview: In practical terms, an SBLC transaction works much like a regular letter of credit in terms of procedure, involving a series of steps and multiple parties. Fundamentally, any letter of credit (standby or documentary) entails an agreement in which an issuing bank, acting at the request (and on behalf) of its client (the applicant), agrees to make payment to a third party (the beneficiary) upon presentation of documents that meet the conditions specified in the credit. The payment can take different forms – it may involve the bank paying the beneficiary directly, accepting or paying drafts (bills of exchange) drawn by the beneficiary, or authorizing another bank to pay or negotiate documents. In all cases, however, payment is conditional on the beneficiary’s compliance with the terms of the credit (such as providing particular documents within the validity period).

In a standby credit, the documents required typically include a demand or statement by the beneficiary declaring that the applicant has not fulfilled the contract (and possibly supporting evidence of default or non-payment), rather than the shipment documents required under a commercial L/C. But the structural framework of using documentary conditions remains the same. Below, we outline the key stakeholders in an SBLC and the typical process flow of issuance and payment.

Key Parties Involved in an SBLC

A standby credit (like other types of LCs) usually involves four primary parties, each with defined roles in the transaction:

• Applicant (Opener) – This is the party at whose request the SBLC is issued. Usually it is the buyer in a sales contract, the importer of goods, or the party who must provide a guarantee (e.g. a contractor guaranteeing performance). The applicant arranges for the bank to issue the standby in favor of the beneficiary. The applicant is responsible for reimbursing the bank if the SBLC is drawn. The applicant also often pays fees for the service.
• Beneficiary – The party in whose favor the SBLC is issued. This is typically the seller or exporter in a trade transaction, or the party who is to receive payment if the applicant fails to perform (for example, the project owner or client of a contractor). The beneficiary is the one who can make a demand under the SBLC to obtain payment, by presenting the required documents that evidence the applicant’s default or other triggering event.
• Issuing Bank (Opening Bank) – The bank that issues the SBLC at the applicant’s request. This bank undertakes the irrevocable obligation to pay the beneficiary provided the terms and conditions of the SBLC are complied with. The issuing bank assumes the credit risk of its client (often requiring collateral or a credit line) and ensures documents are in order before honoring any demand. Usually, the issuing bank is the applicant’s own bank or a bank with whom the applicant has a banking relationship.
• Advising Bank / Nominated Bank – A bank, usually in the beneficiary’s country, that is authorized by the issuing bank to advise the SBLC to the beneficiary and/or to handle documents and payment. In many cases, the nominated bank is simply an advising bank that receives the SBLC from the issuing bank and notifies the beneficiary, acting as a communication channel. In other cases, the SBLC may nominate a specific bank (which could be the advising bank or another bank) to honor or negotiate the beneficiary’s claim – this bank is often called the nominated bank or the paying bank. If the SBLC is confirmed, this bank may also act as a confirming bank (adding its own guarantee of payment). For simplicity, we can view the intermediary bank in standby transactions as the advising/nominated bank that facilitates the process for the beneficiary.

Additionally, other banking parties can be involved depending on the structure:

• Confirming Bank – If the beneficiary requires extra security, a local bank might confirm the SBLC. A confirming bank adds its own undertaking in addition to the issuing bank’s, promising to pay the beneficiary if the documents are compliant, thereby taking on the issuing bank’s credit risk. Confirmation is more common in documentary LCs, but can be used for SBLCs especially if the beneficiary is unsure of the issuing bank’s standing.
• Negotiating Bank – In a transferable or negotiable credit scenario, a bank (often the nominated bank) might negotiate by purchasing or advancing funds against the beneficiary’s documentary claim. This is uncommon in pure SBLC cases (since standby drafts are rare), but can occur if the standby allows drawing by time draft, etc.
• Transferring Bank – If the SBLC is transferable, a transferring bank may be involved to transfer the benefit of the SBLC (in whole or part) to one or more secondary beneficiaries (for example, from a general contractor to a subcontractor). This is also more typical with documentary LCs but technically possible with SBLCs if they are expressly made transferable.

The roles above are all defined in the SBLC terms. In many standby credits, the process is simpler: the issuing bank sends the SBLC via a correspondent bank to the beneficiary (advising bank function), and the beneficiary, if it needs to make a claim, will work through that correspondent to get paid.

Typical SBLC Transaction Flow

The lifecycle of a standby letter of credit involves several key steps and communications between these parties. A generalized process is as follows (assuming an SBLC is being used to secure a sales contract between an importer (applicant) and an exporter (beneficiary)):

1. Application and Issuance: The applicant applies to its issuing bank to have a standby letter of credit opened in favor of the beneficiary. The bank evaluates the request, and if it agrees (often after approving credit or securing collateral from the applicant), it issues the SBLC with specific terms (amount, expiry, conditions for drawing, documents required, etc.).
2. Advising the SBLC: The issuing bank transmits the SBLC to a bank in the beneficiary’s country, typically a trusted correspondent or the beneficiary’s bank, with instructions to advise the SBLC to the beneficiary. This is done via secure SWIFT message or other authenticated means. The chosen advising bank receives the SBLC and notifies the beneficiary that the standby letter of credit is now available, forwarding its details.
3. Beneficiary’s Acceptance: The beneficiary reviews the SBLC terms (usually through the advising bank). If the terms conform to what was agreed in the contract (e.g., the required documents and conditions are acceptable), the beneficiary will accept it. (If not, the beneficiary would ask for an amendment. Amendments, such as extending validity or changing amount, must be issued by the issuing bank and approved by all parties, particularly the beneficiary.)
4. Contract Performance: The underlying contract between the applicant and beneficiary is then performed. In a normal scenario, the beneficiary delivers the goods or services, and the applicant pays as agreed, without needing to use the SBLC. The SBLC remains in the background during this time. It is only if something goes wrong that we move to the next steps. (In a documentary L/C, the next steps would be presentation of shipping documents for payment, but in an SBLC these steps occur only on default.)
5. Presentation of Claim Documents: If the applicant fails to fulfill the contract – for example, fails to pay for delivered goods, or fails to perform services, or any other trigger event specified in the SBLC – then the beneficiary may make a demand under the SBLC. To do so, the beneficiary must compile and submit the documents stipulated by the SBLC. At a minimum, this usually includes a written demand for payment (or a signed statement/certificate) asserting that the applicant has not honored its obligations. Other required documents could be an unpaid invoice, a notice of default, or even proof of shipment or contract performance (depending on how the SBLC is worded). The beneficiary presents these documents to the nominated bank (often the same as the advising bank).
6. Document Examination: The nominated or advising bank examines the presented documents to ensure compliance with the SBLC terms. If this bank is acting as a paying or confirming bank, it will also take up the obligation to pay upon determining that the presentation is conforming. It forwards the documents to the issuing bank (unless it’s authorized to pay immediately under confirmation). The issuing bank likewise examines the documents. It is crucial to note that banks deal only with documents, not the actual goods or the underlying situation. If the documents on their face meet all the requirements of the SBLC, the issuing bank must honor the demand unconditionally, regardless of any disputes between applicant and beneficiary in the underlying contract.
7. Payment to Beneficiary: The SBLC is then considered fulfilled (or it may remain open until its expiry to cover any further possible default, if partial drawings are allowed, etc., but most standby credits are for one-time use or reduce their available amount after a drawing. In practice, the issuing bank often routes the payment through the nominated/advising bank to the beneficiary. The beneficiary thus receives the funds due under the SBLC.
8. Reimbursement and Settlement: Finally, the issuing bank will seek reimbursement from the applicant for the amount paid out, as per their agreement (the applicant typically is obligated to repay the bank and pay any fees, and any collateral might be drawn upon). The SBLC is then considered fulfilled (or it may remain open until its expiry to cover any further possible default, if partial drawings are allowed, etc., but most standby credits are for one-time use or reduce their available amount after a drawing).

If the applicant fulfills the contract obligations properly, none of the drawing steps are invoked and the SBLC simply expires at the end of its validity period (or is cancelled with consent of beneficiary). In that case, there is no payout, and the instrument served only as a guarantee.

Documentary Requirements: It bears emphasizing that the exact documents required for an SBLC draw must be specified in the SBLC text itself. The bank’s obligation to pay arises only upon presentation of those exact documents (within the SBLC’s validity). For example, an SBLC, might require: (a) the beneficiary’s signed statement declaring the applicant’s default in payment for invoice #XYZ under contract #123, and (b) a copy of the unpaid invoice, and (c) perhaps a copy of a bill of lading showing goods were shipped. The beneficiary must provide all of these in the required format and by the expiry date in order to get paid. Banks will carefully check the documents for strict compliance (this is often called the “doctrine of strict compliance” in letters of credit practice). If documents are missing or not exactly as required, the banks can refuse payment. This strict documentary procedure gives the SBLC its reliability, minimizing ambiguity and fraud by requiring evidence on paper. However, it also means the beneficiary must pay close attention to the SBLC terms to execute a proper draw.

Obligation of the Bank: Once a complying demand is presented, the issuing bank’s obligation to pay is triggered. The bank pays against documents, not based on the actual performance of the contract. This means even if, for instance, the applicant argues that the beneficiary didn’t perform or that there is a dispute, the bank will pay as long as the documents formally conform. Conversely, if the beneficiary fails to present the required papers correctly, the bank will not pay, even if the applicant did default. In this way, an SBLC (like any LC) is independent of the underlying contract – the bank deals only in documents and its own undertaking, which is a key principle in letter of credit law.

Example: Suppose a supplier is selling machinery to a buyer with payment due 60 days after delivery. The buyer opens an SBLC in favor of the supplier for the invoice amount. If the buyer pays on time, the SBLC isn’t used. If the buyer fails to pay by day 60, the supplier can send the bank a sight draft for the amount, a copy of the unpaid invoice, and a statement that payment hasn’t been received by the due date. The bank will verify these documents and then pay the supplier under the SBLC, ensuring the supplier is not out the money even though the buyer defaulted. The buyer will then owe that amount (plus fees) to the bank.

This mechanism allows business to proceed where trust is limited – the supplier was willing to ship because an SBLC assured payment even if the buyer defaulted, and the buyer’s promise was backed by its bank.

How Much Does a Letter of Credit Cost?

One practical consideration when using standby or documentary letters of credit is the cost of these instruments. A letter of credit provides a valuable guarantee of payment security for both parties, but it can be a relatively expensive financial tool due to various bank fees and commissions involved. The exact financial terms and fees for an LC depend on the policies of the specific issuing bank and the complexity of the transaction. Banks may quote the cost as a percentage of the credit amount or as fixed fees for different services.

Common fees and charges associated with SBLCs (and LCs generally) include:

• Issuance Fee: Charged by the issuing bank for opening the letter of credit. For example, this might be around 0.25% of the SBLC amount (often calculated per annum if the SBLC is open for more than a year, or per quarter).
• Confirmation Fee: If the beneficiary requests a confirmation, the confirming bank will charge a fee for adding its guarantee. This fee depends on the confirming bank’s risk assessment of the issuing bank and country risk, and is often a percentage of the amount per specified period.
• Advising Fee: A fee for the advising bank to inform the beneficiary of the LC issuance (this fee is usually modest, sometimes paid by the issuing bank or applicant).
• Document Examination (Negotiation) Fee: The banks involved may charge a fee for checking the documents and handling the presentation. This might be quoted as, say, ~0.2% of the amount for document handling by the issuing or nominated bank.
• Amendment Fee: If the SBLC’s terms (amount, validity, etc.) need to be changed, banks charge for each amendment. If the amount is increased, an extra issuance commission may apply on the increase.
• Increase/Extension Fee: Related to amendments, if the amount is increased or the expiry extended, additional fees or prorated commission will be charged.
• Payment Fee: When payment is made under the LC, a fee may be charged for the funds transfer. For instance, an issuing or paying bank might charge a payment commission (e.g. not less than 0.1% of the amount) for effecting the payout.
• Other Service Fees: Banks can also charge for other activities such as swift transmission charges, courier costs for original documents, discrepancy fees (if documents presented have discrepancies and the beneficiary still asks the bank to seek approval from applicant to pay), etc.

The party that bears these costs can vary. Typically, the applicant pays the issuance fee and often any advising or confirmation fees (the applicant might have to reimburse those as part of the LC agreement). However, sometimes a contract will state that the beneficiary bears certain fees (for example, if they insist on confirmation, they might cover the confirming bank’s fee). Responsibility for fees is usually outlined in the sales contract or the letter of credit application. UCP 600 rules, for instance, specify default allocations (e.g., the applicant covers issuing bank charges, beneficiary covers their bank’s charges, unless otherwise agreed). In standby practice, often the applicant, as the one requesting the SBLC, will pay most of the associated fees, but it can be negotiated.

Because of these costs, companies considering an SBLC weigh the benefit of security against the expense. SBLCs are often justified for high-value or high-risk contracts where the cost of an LC is a small percentage relative to the potential loss if the deal goes wrong. As noted earlier, ensuring timely fulfillment of financial obligations – especially in expensive projects or large trade deals – justifies the additional expense of an SBLC in many cases (Резервный аккредитив (SBLC): финансирование и банковские кредиты). Many firms are willing to incur bank fees in order to protect themselves from non-payment or non-performance that could be financially devastating.

Also note that banks will typically require the applicant to have sufficient creditworthiness to cover the SBLC. This might mean the applicant must provide cash collateral (a deposit) for some or all of the SBLC amount, or have a line of credit approved. If cash collateral is taken (often called a “covered” or “funded” SBLC), that means the applicant’s funds are frozen by the bank as security – which has its own opportunity cost for the applicant. In practice, fully cash-covered LCs are not very common in competitive market economies, since few companies are willing to tie up large sums of money to obtain what is essentially a paid service (Резервный аккредитив (SBLC): финансирование и банковские кредиты). More often, banks issue SBLCs on an unfunded basis, relying on the applicant’s credit line or other security (guarantees, charge on assets, etc.), and perform careful credit analysis for each client (Резервный аккредитив (SBLC): финансирование и банковские кредиты). This way, the applicant doesn’t have to freeze cash, but the bank takes on risk and thus charges fees accordingly.

To summarize, an SBLC can be a valuable but costly instrument. All parties should be clear on the fee structure before proceeding. Applicants should shop around or negotiate with banks for competitive rates, and beneficiaries should understand who will bear which fees. Despite the costs, the risk mitigation provided by an SBLC often makes it worthwhile for high-stakes transactions.

Types of Letters of Credit (Modern Classification)

Letters of credit come in many types and variations, tailored to different business needs. The classification of LCs can be based on various criteria such as whether they are revocable or irrevocable, how payment is made (at sight, deferred, acceptance, negotiation), the roles banks play (confirmed vs unconfirmed, transferable, etc.), and the underlying purpose (commercial vs standby). Below we outline some major types of letters of credit and where standby credits fit among them.

One important classification aspect is whether an LC is secured by cash deposit (collateralized) or not. A covered (funded) letter of credit means the applicant has deposited the full amount (or a large portion) with the issuing bank as a pledge, assuring the bank of reimbursement. An uncovered letter of credit means it is issued on the bank’s credit to the applicant (no specific cash collateral, just the applicant’s promise and the bank’s risk assessment). As mentioned, the majority of LCs issued are uncovered, since most companies are unwilling or unable to immobilize significant funds just to secure the LC (Резервный аккредитив (SBLC): финансирование и банковские кредиты). Banks manage the risk by vetting clients and often charging higher fees or requiring other security if needed.

Another key criterion is the ability to revoke or amend the credit unilaterally. This gives us:

• Revocable Letter of Credit: A revocable LC can be canceled or changed by the issuing bank at any time without the beneficiary’s consent. For example, the bank could reduce the amount or validity if it sees fit, perhaps at the applicant’s request, without notifying the beneficiary until after the fact. This obviously provides little security to the beneficiary, since the promise can be withdrawn. Revocable credits do not create a legally binding obligation on the issuing bank to pay, and thus are rarely used in modern international trade (they are largely considered obsolete in UCP 600, which assumes credits are irrevocable unless otherwise stated) (Резервный аккредитив (SBLC): финансирование и банковские кредиты).
• Irrevocable Letter of Credit: An irrevocable LC cannot be canceled or materially amended without the agreement of all parties, particularly the beneficiary. It represents a firm commitment by the issuing bank that cannot be withdrawn as long as the beneficiary complies with the terms. Virtually all LCs in use today are irrevocable. The SBLC, by its nature, is issued as an irrevocable instrument – the beneficiary must be able to rely on it, otherwise it would defeat the purpose of a guarantee (Резервный аккредитив (SBLC): финансирование и банковские кредиты). Once an SBLC is issued, the bank cannot revoke it on a whim; it remains in force until expiry or fulfillment, giving the beneficiary a solid assurance.

Letters of credit, whether standby or documentary, open up a wide range of commercial possibilities by providing security to both sides of a deal. Each LC, however, contains precise conditions for compliance (for example, it might specify payment “at sight” upon presentation of documents, or payment after 90 days, etc., and whether partial shipments are allowed, etc.). These specifics allow LCs to be fine-tuned to the needs of a transaction.

Below is a classification of some common types of letters of credit by their usage method or special purpose, along with brief descriptions:

Type of Letter of Credit	Description
Documentary Letter of Credit (Commercial LC)	Standard form of LC used to facilitate **payment for goods or services**. The issuing bank undertakes to pay the beneficiary (exporter) upon presentation of specified shipping and commercial documents (invoice, transport documents, etc.) that prove the seller has performed as agreed. This ensures the seller gets paid and the buyer only pays upon receiving documents that typically allow possession of goods.
Standby Letter of Credit (SBLC)	A **“backup” letter of credit** that functions as a guarantee. It is only drawn upon if the applicant fails to perform or pay as agreed. The SBLC’s usage is analogous to a bank guarantee – the documents required will evidence the applicant’s default (such as a declaration of non-payment). Common in securing performance, advance payment refunds, or financial obligations, especially in the U.S. and international project finance.
Revolving Letter of Credit	An LC that **automatically reinstates** its amount after it’s been used, up to a certain number of times or until a maximum aggregate is reached. This is used for regular shipments or continuous business, so the buyer doesn’t need a new LC for each shipment. For example, a revolving LC might allow $100,000 per month to be drawn for 12 months, resetting each month.
Transferable Letter of Credit	An LC that allows the **beneficiary to transfer all or part** of the credit to one or more third parties (second beneficiaries). Often used when the beneficiary is an intermediary trader or general contractor who needs to forward the credit on to their suppliers/subcontractors. Only one transfer is typically allowed, and terms must be transferred exactly except for amount and dates (as permitted by the original LC).
Back-to-Back Letter of Credit	Although not listed in the original table, a back-to-back LC is worth mentioning: it involves using one LC (from buyer to intermediary) as collateral for another LC (from intermediary to ultimate supplier). It’s a workaround if a transferable LC is not possible. The intermediary uses the first LC to convince a bank to issue a second LC in favor of the supplier. This effectively creates two interdependent LCs for one transaction.
Red Clause Letter of Credit	An LC that contains a special clause (historically printed in red ink) allowing the beneficiary to draw **advance payments** before shipping the goods. It’s often used to provide the seller with financing for purchasing or manufacturing the goods. The advance is then deducted from the final shipment documents drawing. A “green clause” LC similarly allows advances against storage of goods in a warehouse.
Standby with Transfer of Proceeds	The table above mentioned **“assignment of proceeds”** of an LC: This is not exactly a type of LC, but a mechanism where the beneficiary instructs the bank to pay a portion of the funds to a third party once the credit is honored. It differs from a full transfer in that the original beneficiary remains the beneficiary, but assigns some proceeds to another party (often a supplier or lender). Many LCs permit assignment of proceeds even if they are not transferable.

(The original Russian article provided a table classifying ‘transit letter of credit’ and ‘assignment of proceeds.’ In international practice, these terms correspond to intermediary bank arrangements and assignment of proceeds, as described above.)

As seen, standby LCs (SBLCs) are one category among various specialized LCs. SBLCs are always irrevocable and usually treated separately from commercial LCs due to their guarantee-like nature. The classification of LCs continues to evolve with business needs, and there are other types and sub-types in use. The key is that all operate on the same fundamental principle: the bank’s conditional obligation to pay against documents, which can be adapted to many scenarios in trade and finance.

What is the Difference Between a Standby LC and a Documentary LC?

Standby vs. Documentary Letter of Credit: While both standby letters of credit and traditional documentary letters of credit are tools to secure obligations in commercial transactions, they serve opposite purposes in terms of when and why payment is made.

A documentary letter of credit (the regular import/export LC used in trade) is intended to ensure the seller gets paid when they perform. The bank pays against documents like bills of lading, inspection certificates, etc., which indicate the goods/services have been provided as per contract. If everything goes well, the documentary L/C is utilized for payment of the contract price. Essentially, it’s a payment method with built-in security: the seller knows the bank will pay if they ship the goods correctly, and the buyer knows the bank won’t pay unless those shipping documents are provided (ensuring contract performance). In this way, the bank actively facilitates the transaction – it intermediates the exchange of money for documents.

On the other hand, a standby letter of credit is intended as a fallback to compensate the beneficiary if the applicant fails to perform some obligation. In a typical SBLC scenario (like a payment guarantee), the transaction between buyer and seller is supposed to be settled directly (perhaps on open account terms or a later payment due date). The bank remains passive in the background unless something goes wrong. Only if the applicant does not pay or perform as promised does the SBLC come into play. The beneficiary then presents a demand under the SBLC to recover losses or payment due. In effect, the standby is insurance against default, not the primary payment mechanism for a successful transaction.

To put it succinctly: a documentary L/C is used as the vehicle of payment in a normal completion of a contract, whereas an SBLC is used as the vehicle of compensation in the event of a contract default (Резервный аккредитив (SBLC): финансирование и банковские кредиты) (Резервный аккредитив (SBLC): финансирование и банковские кредиты). The bank’s role in a documentary credit is much more engaged (collecting documents, often financing the buyer in the interim, etc.), while in a standby credit the bank’s role is mostly dormant until a claim is made.

Another way to view the difference is to consider what each guarantees:

• The documentary credit guarantees to the seller that if they perform (ship goods as per conditions), they will receive payment, effectively guaranteeing performance of the buyer in paying for a properly executed contract.
• The standby credit guarantees to one party (usually the seller or service buyer) that if the other party fails in their performance or payment, then the bank will cover the loss, effectively guaranteeing compensation for non-performance.

Despite these differences in function, both instruments share many common characteristics: both are independent of the underlying contract (banks only care about documents), both give comfort to counterparties in a deal, and both are governed by similar principles and often the same sets of rules (UCP or related ICC rules).

A few more specific distinctions and points to note:

• Documents required: In a documentary L/C, the required documents typically include commercial invoices, transport documents (like bills of lading or airway bills), packing lists, inspection certificates, etc. These prove positive performance (goods have been shipped in good order). In an SBLC, the required documents usually focus on proving negative performance or a claim situation – e.g. a demand statement, default notice, or maybe evidence of what was supposed to happen (like a copy of a contract or invoice) plus a declaration it didn’t happen. For example, to draw under a financial SBLC, a beneficiary often provides a sight draft and a written statement that “payment X due on date Y under contract Z has not been received.”
• Bank involvement: As mentioned, with a documentary credit, the issuing bank actively engages upon presentation of documents (which happens in the normal course of fulfilling the contract). With an SBLC, the issuing bank waits passively and hopes not to hear from the beneficiary; if the beneficiary never presents a claim, that means the applicant fulfilled their obligation and everyone is content. The bank essentially only steps in if the applicant defaults.
• Frequency of use: Documentary credits have been very popular in Europe and globally historically for trade payment, but their use has declined somewhat with the rise of open account trade and other financing tools (except for certain markets and commodities). SBLC use, conversely, has risen, especially in the U.S. and in international project finance, because they provide flexibility and can secure a broader range of obligations (not just payment for goods, but things like performance of services, or financial covenant compliance, etc.). The SBLC is in many ways an alternative to the bank guarantee that is more acceptable in international contexts where everyone understands letters of credit rules.

Importantly, the term ‘letter of credit’ in its broader sense includes both standbys and documentary credits. But colloquially, if someone just says “letter of credit,” they often mean the commercial/documentary kind used for paying for shipments, whereas they would specifically say “standby” to mean the guarantee instrument. Indeed, the ICC rules UCP 600 were drafted mainly with documentary credits in mind, and ISP 98 was later created specifically to address standbys, because many felt that UCP did not adequately cover the unique aspects of standby credits.

Standby LCs may be issued subject to ISP 98 (International Standby Practices) as a more fitting rule set, though they can also be issued under UCP 600, which is the same rules used for commercial LCs (Резервный аккредитив (SBLC): финансирование и банковские кредиты). The choice often depends on the preference of the issuing bank or the beneficiary. Many U.S. banks favor ISP 98 for standbys, whereas some other banks use UCP 600 for all LCs (adding special clauses to handle discrepancies in standby context).

In summary, while an SBLC and a documentary L/C are structurally similar (both are letters of credit undertakings by banks), the key difference lies in the event that triggers payment and the role they play in the transaction’s execution. One pays when obligations are correctly fulfilled, the other pays when obligations are not fulfilled. Understanding this difference helps parties choose the right instrument for their needs: if you want guaranteed payment for delivery of goods, use a documentary L/C; if you want a safety net in case your counterparty doesn’t pay or perform, an SBLC is appropriate.

SBLC or Bank Guarantee? – Comparing Standby LCs with Guarantees

Given that a standby letter of credit functions much like a guarantee, one might ask: When should we use an SBLC and when a bank guarantee? What are the differences?

We have already noted the similarities: Both SBLCs and demand guarantees serve to protect parties in a contract by ensuring payment or compensation on the occurrence of certain conditions. Both instruments only come into play if some specified event occurs (e.g., non-payment, non-performance, or other default), and both require the beneficiary to present stipulated documents (such as a demand letter, etc.) to claim payment. They do not allow arbitrary calls; the claim must meet the agreed terms, thus preventing wrongful or early draws. Additionally, both are issued by banks (or financial institutions) and carry the weight of a bank’s credit, and thus both are used only when applicants pass the bank’s scrutiny and agree to the bank’s terms.

Security and assurance: In practice, both a high-quality bank guarantee and an SBLC from a reputable bank can provide equivalent security. In fact, in some cases, except for the title of the instrument, the content and effect might be no different at all from a beneficiary’s perspective. It has been observed that sometimes when dealing with U.S. parties, simply calling something a “standby letter of credit” instead of a “bank guarantee” can be the difference between acceptance or not – even if the text is essentially the same. In other words, an SBLC is often treated as a guarantee in substance, and banks issue SBLCs to comply with markets where direct guarantees aren’t common. There have been cases where one could literally replace the words “bank guarantee” with “standby letter of credit” in a document, and the counterparty (especially if accustomed to U.S. practices) will readily accept it (Stand-by Letter of Credit (SBLC): financing services and bank loans).

Despite their similar purpose, there are a few notable differences in how they are regulated and used:

• Governing Rules and Standards: Perhaps the biggest difference is the legal and rules framework. Standby LCs are typically governed by the international LC rules (UCP 600 or ISP 98), which are quite standardized across the globe. Bank guarantees, on the other hand, historically did not have a single set of global rules. They have often been subject to local law in each country, and the practices could vary. To harmonize guarantee practice, the ICC introduced the Uniform Rules for Demand Guarantees (URDG), with the latest version being URDG 758 (2010). URDG 758 provides a similar standardized approach for guarantees as UCP does for LCs. Many modern international guarantees will incorporate URDG 758, bringing them closer in line to SBLCs (legally speaking). However, not all guarantees use these rules; some are issued referencing local civil code articles or not referencing any rules at all. SBLCs, by virtue of being a type of LC, more consistently use the well-known LC rules of the ICC. This means that an SBLC, might be seen as more globally uniform and predictable in terms of enforcement.
• Formality and Format: An SBLC’s terms and format are often highly formalized, commonly transmitted via SWIFT MT760 or similar standardized message. These contain fields for all essential terms, making them very clear-cut. Bank guarantees, depending on jurisdiction, might be written in varying formats (letter form, deed form, etc.) and might include certain legal clauses peculiar to local law (like referencing civil code provisions, requirements for notices, etc.). SBLCs tend to stick to the standard terminology of credits (beneficiary statement, documents, expiry, drawing mechanism, etc.), which can reduce ambiguity. As noted in the Russian text, the SBLC’s content being sent in highlighted SWIFT fields (e.g., field 44 for expiry date, 47 for conditions, etc.) ensures that all required information is structured (Stand-by Letter of Credit (SBLC): financing services and bank loans). Guarantees can be more free-form, though URDG is making them more standardized too.
• Use in fund transfers: One interesting difference highlighted is that an SBLC can sometimes be used creatively as a tool in structured finance to optimize cash flows, whereas a bank guarantee cannot directly serve as a payment mechanism. For instance, parties might set up an SBLC that can be drawn to effect payment under certain conditions, thus moving funds through banking channels in a particular way. A pure guarantee (outside of an LC framework) typically isn’t used to deliberately transfer funds except upon default, and it’s usually not considered a “payment method.” This makes SBLCs a bit more versatile in some financing arrangements (Резервный аккредитив (SBLC): финансирование и банковские кредиты) (Резервный аккредитив (SBLC): финансирование и банковские кредиты). However, this is a nuanced use-case and in straightforward terms, both are not meant for routine payments, only contingency.
• Legal Nature: In some legal systems, a demand guarantee is considered a distinct legal instrument separate from letters of credit, with its own jurisprudence. In the U.S., however, standby LCs are governed by LC law (primarily UCC Article 5 in domestic law) and case law treating them largely like any other LC. Some countries may have specific statutes for bank guarantees. This is more of interest to lawyers: generally, a beneficiary doesn’t care if it’s called guarantee or SBLC as long as it’s payable on demand. But if a dispute arises, the governing law and rules (URDG vs UCP/ISP) might affect outcomes like how strict “on demand” is interpreted, whether injunctions to stop payment are possible, etc.
• Preference in markets: U.S. and many international markets prefer SBLCs (hence ISP 98’s creation), while many European, Asian and Middle Eastern businesses are very familiar with both direct guarantees and standbys. Some countries’ public sectors may only accept guarantees (not understanding SBLC), whereas American parties will practically always use SBLC over guarantee. It can sometimes be a matter of terminology preference and banking practice in different regions.

From a beneficiary’s perspective, an SBLC from a reputable foreign bank might be preferable to a foreign bank guarantee because the SBLC will likely explicitly state it is subject to uniform rules (like ISP98 or UCP600), which gives confidence in how disputes will be resolved (under international practice standards). A guarantee might or might not mention URDG, and if not, one must consider the governing law clause to understand how it will be interpreted.

In summary, SBLCs and bank guarantees are functional equivalents in many cases. The decision of which to use may depend on what terminology the parties are more comfortable with, whether they want it explicitly governed by ICC rules (URDG or ISP), and any regulatory restrictions (for example, some banking regulators consider an SBLC as a contingent liability similar to a guarantee – there may be slight differences in how they count toward credit exposure or capital requirements, but that’s an internal bank issue). In international tenders or contracts, you’ll often see wording like “an irrevocable standby letter of credit or bank guarantee, at the buyer’s option” as acceptable forms of security.

To illustrate the interchangeability: Imagine a European seller asks for a “first-demand bank guarantee” from the U.S. buyer. The U.S. buyer’s bank may respond that it can issue an SBLC (but not a guarantee). The seller might initially be concerned, but the bank and buyer can explain that the SBLC will be worded to function identically to the requested guarantee (and could even be governed by URDG 758 if that’s acceptable, or by ISP 98 which is equally secure). Once the seller understands the nature, they accept the SBLC, and the deal proceeds. In effect, only the name and format differed, not the security provided.

Finally, it’s worth noting that in some cases, companies prefer SBLCs because banks themselves are very experienced in handling LCs, and having the instrument under LC practice might ensure smoother processing. Banks typically have dedicated trade finance departments for LCs and SBLCs. A demand guarantee (especially if not under URDG) might be handled by legal departments and could be subject to local banking formalities. This is another subtle advantage of SBLCs – they fall neatly within trade finance operations globally.

Use Cases and Applications of SBLC

Standby letters of credit are used in a wide range of situations in international business, trade, and finance. Their versatility as a guarantee instrument means they can secure many types of obligations. Here we discuss some common use cases and scenarios where SBLCs are particularly beneficial, as well as trends in their usage across different regions and industries.

Entering Foreign Markets: Companies expanding into international markets often face unfamiliar counterparties and higher perceived risks. A business might hesitate to engage in a large contract abroad due to concerns about the foreign partner’s creditworthiness or reliability. In such cases, an SBLC can provide the necessary assurance to proceed. For example, an exporter selling to a new importer in a developing market might request an SBLC to secure payment, mitigating the risk of non-payment. Likewise, an importer might ask for an SBLC to secure performance if they prepay or if the exporter’s performance is crucial. Using SBLCs can thus enable commerce that otherwise might not happen due to lack of trust. In times of geopolitical uncertainty or economic volatility, standby credits are even more valuable to ensure contracts are executed safely (Stand-by Letter of Credit (SBLC): financing services and bank loans).

Historical and Geographical Usage: SBLCs have been especially popular in the United States and Japan, where traditional European-style bank guarantees were less common (Stand-by Letter of Credit (SBLC): financing services and bank loans). In the U.S., as noted, banks generally issue standbys instead of guarantees, so domestic trade and even municipalities use SBLCs (for example, to secure performance in construction projects or as bid bonds, etc.). Globalization has spread the use of SBLCs to other regions: European and Asian banks have increased their issuance of SBLCs, influenced by the practices of American banks and the demands of international transactions (Stand-by Letter of Credit (SBLC): financing services and bank loans). Today, SBLCs are widely accepted alongside bank guarantees in most markets. North American banks and companies have certainly played a role in familiarizing European partners with SBLCs (Stand-by Letter of Credit (SBLC): financing services and bank loans).

Typical SBLC Applications:

SBLCs can be used to secure virtually any contractual or financial obligation where one party wants a guarantee from the other. Some common applications include:

1. Payment Guarantee in Trade: Perhaps the most common use is as a fallback for payment in trade contracts. If a buyer prefers to pay on open account (after receiving goods) and the seller is unsure of the buyer’s ability to pay, the buyer may provide an SBLC assuring payment. If the buyer fails to pay by the due date, the seller can draw under the SBLC for the amount due. This arrangement is often chosen when a normal documentary credit is seen as too costly or cumbersome, yet the seller still wants security. In fact, one scenario explicitly noted is when the importer’s costs for opening a regular documentary letter of credit would be unreasonably high, they might opt for an SBLC instead (Stand-by Letter of Credit (SBLC): financing services and bank loans). Standbys typically have simpler documentation than full LCs and might avoid some banking fees associated with document handling (though as we saw, SBLCs have their own fees, but if no default occurs, some fees like document checking don’t incur).
2. Performance Bond / Performance Guarantee: SBLCs are frequently used to guarantee performance of non-monetary obligations. For instance, a construction contract might require the contractor to provide a performance SBLC equal to 10% of the contract price, guaranteeing completion of the project. If the contractor fails, the project owner can claim that 10% as compensation. Similarly, SBLCs are used to ensure maintenance obligations (the contractor will fix defects during the warranty period, or the beneficiary can draw funds) and to ensure fulfillment of service contracts. These SBLCs often require a statement of default and maybe an engineer’s certificate or similar document for drawing.
3. Advance Payment Guarantee: When a buyer or project owner makes an advance payment to a supplier or contractor (for example, 20% down payment before work begins), they often require an SBLC guaranteeing refund of the advance if the supplier fails to deliver. This advance payment SBLC (or guarantee) protects the payer’s money. If the supplier doesn’t perform, the payer calls the SBLC to get their advance back. SBLCs for this purpose are common in manufacturing contracts, construction, and large equipment purchases.
4. Financial Guarantee / Credit Enhancement: SBLCs can serve to guarantee loans or financial obligations. For example, if a subsidiary company takes a loan, the parent company might arrange an SBLC in favor of the lender to guarantee repayment. In project finance, sponsors may provide SBLCs to cover certain contingencies (like debt service reserve SBLCs, which banks can draw on if the project company can’t meet a payment). SBLCs are also used in capital markets – a company issuing commercial paper might have a standby from a bank to guarantee repayment to investors, improving the paper’s credit rating (this is known as a credit-enhanced note, often achieved via a standby or direct pay letter of credit).
5. Bid Bond / Tender Guarantee: When bidding on international tenders, bidders often must submit a guarantee (bid bond) that they will sign the contract and provide a performance guarantee if awarded, or else the bond is forfeited. Banks issue bid bond SBLCs for this purpose, usually for a small percentage of the bid amount (like 2-5%). If the bidder wins but doesn’t follow through, the beneficiary (tendering entity) calls the SBLC to get the bond amount.
6. Standby as Counter-Guarantee: Sometimes a local guarantee is needed in a foreign country (e.g., a foreign government contract requires a guarantee from a local bank). A company’s home bank might issue an SBLC (counter-guarantee) to a local bank, instructing the local bank to issue a local guarantee and providing a claim route. If the local bank has to pay on the guarantee, it will claim under the SBLC from the issuing bank. Essentially, SBLCs are used in guarantee syndications and counter-guarantee structures across borders.
7. Subcontractor and Downstream Guarantees: As mentioned, a contractor might ask its subcontractors to provide SBLCs to back their obligations, similar to how the contractor gives one to the project owner. SBLCs can propagate down the supply chain to ensure accountability at each level.
8. Trade Finance Structures: In some trade finance deals, SBLCs are used in creative ways. For example, parties might sign a sales contract with extended payment terms, and the buyer provides an SBLC that allows the seller to get financing. A bank could discount the SBLC or use it as collateral to lend the seller money (knowing that if the buyer doesn’t pay at due date, the SBLC covers it). This can be seen as an alternative to documentary LCs or factoring.

The range of application of SBLCs is quite wide, and indeed the Russian source lists multiple such scenarios and services where SBLCs are useful (Stand-by Letter of Credit (SBLC): financing services and bank loans) (Stand-by Letter of Credit (SBLC): financing services and bank loans). Let’s highlight a few specific scenarios noted:

• When the foreign trade contract payment terms do not call for a documentary credit. For instance, if a contract is based on open account terms (payment 60 days after delivery), but the seller wants extra security, an SBLC can be layered on top of the contract as a guarantee (Stand-by Letter of Credit (SBLC): financing services and bank loans). This provides the benefit of a letter of credit’s security without changing the agreed payment method in the contract.
• When a buyer has sufficient working capital to pay on time, but the supplier insists on a more secure payment form than a simple transfer. In such cases, the parties might agree to use promissory notes or an open account with an SBLC as backup (Stand-by Letter of Credit (SBLC): financing services and bank loans). For example, the buyer might issue a promissory note for the amount due in 60 days, and secure it with an SBLC. If the buyer pays, fine; if not, the seller can either present the note for payment or invoke the SBLC to get the money. This combination can sometimes be more cost-effective than a full documentary LC for every shipment, yet still give the seller confidence.
• When partners need to strengthen payment guarantees for a series of shipments. The text mentioned an example of covering one or two shipments with an SBLC to guarantee payment (Stand-by Letter of Credit (SBLC): financing services and bank loans). If the buyer pays normally for those shipments, the SBLC isn’t used; but if the buyer fails on one, the seller can draw or perhaps use the SBLC to support drafting a bill of exchange. This scenario shows SBLC as a way to secure a continuing relationship without having an LC for each individual shipment.

Beyond trade, SBLCs are found in project finance and infrastructure heavily. For instance, independent power projects may use SBLCs to secure obligations of offtakers (e.g., a state utility might provide an SBLC to guarantee its payments for power purchased, which the project company can draw if the utility doesn’t pay). Less traditionally, SBLCs have been used to guarantee obligations like environmental remediation performance, lease payments, and even in court (like guaranteeing legal settlement payments or fines until paid).

From the beneficiary’s viewpoint, having an SBLC means turning a counterparty risk into a bank risk. And banks are generally more creditworthy or at least easier to claim against than a potentially non-cooperative counterparty. This security can enable businesses to venture into deals with new partners, new markets, or high-risk ventures that otherwise would be untenable. High-investment projects, for example, often require every major participant to back their commitments with SBLCs or guarantees to ensure the project isn’t jeopardized by any single party’s default.

Use in High-Risk Projects: As noted in the Russian text, the biggest benefit of SBLCs is felt in commercial deals and projects that are high-risk (Резервный аккредитив (SBLC): финансирование и банковские кредиты). If it’s difficult for a project owner to thoroughly vet a contractor, or if there are objective concerns about a contractor’s financial liquidity or capability to complete the project, an SBLC significantly reduces the risk. Likewise, when dealing with a brand new partner without a track record, or when undertaking a large capital-intensive project (where the stakes are high and a failure would be very costly), standby credits provide a layer of protection that can be the difference between moving forward or not (Резервный аккредитив (SBLC): финансирование и банковские кредиты) (Резервный аккредитив (SBLC): финансирование и банковские кредиты).

Finally, smaller companies can also use SBLCs to build credibility. For example, a small supplier wanting to win a deal with a large overseas buyer could offer an SBLC to the buyer to alleviate concerns that the small supplier might not perform or refund advance payments. Similarly, an SME importer can secure an SBLC to give a foreign exporter confidence to ship on open account terms.

To sum up, SBLCs have myriad uses across industries: from securing trade in commodities, machinery, or consumer goods, to safeguarding construction and engineering contracts, to supporting financial obligations in loans and securities. Whenever there is a defined obligation and a need for a guarantee, an SBLC is an option.

International Rules Governing SBLCs and Bank Guarantees (UCP 600, ISP 98, URDG 758)

As mentioned earlier, standby letters of credit and demand guarantees are typically subject to sets of international rules and practices that govern their operation. Understanding these rules is crucial for anyone dealing with SBLCs, as they define the rights and obligations of banks and beneficiaries, and they ensure that these instruments are interpreted consistently worldwide. The main rule frameworks are published by the International Chamber of Commerce (ICC):

• UCP 600 (Uniform Customs and Practice for Documentary Credits) – This is the most widely used set of rules for documentary letters of credit. Published by the ICC (Publication No. 600, effective 2007), UCP 600 provides standardized provisions for issuing, confirming, transferring, and honoring letters of credit. While aimed at commercial LCs, many standby LCs have historically been issued under UCP 600 as well. UCP 600 covers things like definitions, how banks must examine documents, what constitutes a complying presentation, handling of discrepancies, etc. It does not have force of law but is incorporated by reference into the text of the LC (e.g., an LC will say “This credit is subject to UCP 600”). By doing so, all parties agree to abide by these rules, which greatly reduces misunderstandings. One limitation is that UCP 600 was not specifically designed for standbys, so certain articles (like those about transport documents, or requirement that credits should not be payable on default alone) are less applicable or need careful handling in standby contexts.
• ISP 98 (International Standby Practices 1998) – As the use of SBLCs grew, the ICC (in collaboration with the Institute of International Banking Law & Practice) developed rules tailored for standby letters of credit. ISP 98 (ICC Publication No. 590, effective January 1, 1999) is a comprehensive set of practice rules specifically for SBLCs. It addresses many situations unique to standbys, such as what constitutes a proper demand, how to treat extension or reduction of amounts (“evergreen” clauses), and it omits provisions irrelevant to standbys (like those dealing with transport documents in commercial LCs). ISP 98 has been endorsed by UNCITRAL as well, highlighting its international acceptance ( ISP98 – IIBLP). An SBLC will state “This standby letter of credit is issued subject to ISP 98” to apply these rules. Many practitioners prefer ISP 98 for standbys because it can make handling default demands more straightforward. For example, ISP 98 explicitly allows certain statements to be used for claims and covers concepts like force majeure in presentations, etc., which supplement the general UCP approach. If an SBLC is subject to ISP 98, one can be assured it’s a true standby in design.
• URDG 758 (Uniform Rules for Demand Guarantees) – This is the ICC’s rule set for demand guarantees, updated in 2010 (ICC Publication No. 758). Like UCP and ISP, URDG 758 provides standardized rules: it defines guarantees, counter-guarantees, and details how claims should be made and honored, examinations of demands, etc. URDG 758 has gained significant international traction; many cross-border bank guarantees now include a clause “This guarantee is subject to URDG 758”. If a guarantee uses these rules, it operates very similarly to an SBLC under ISP in terms of mechanics and obligations. URDG 758 has provisions analogous to LC practices (e.g., five banking days to examine a demand, rules for extending guarantees, etc.). One notable difference is terminology (e.g., URDG uses “guarantor” for issuing bank, “instructing party” for applicant, etc.). For someone dealing with either instrument, knowing URDG 758 is in force provides confidence that the guarantee will be handled in a modern, uniform way rather than some unpredictable local custom.

Choosing the Rules: When issuing or receiving an SBLC, the parties (primarily the issuing bank in consultation with applicant and beneficiary) will choose whether it’s subject to UCP 600 or ISP 98 (or even older standby rules like ISP 1983, although those are now obsolete). The trend is towards using ISP 98 for standbys. If nothing is specified, sometimes the default for a bank might be UCP 600, but it’s risky to not specify. Likewise, for a guarantee, stating URDG 758 is highly recommended in international contexts. In practice, you will see SBLCs referencing ISP 98 for purely financial or performance standbys, and occasionally UCP 600 if the standby is issued by a bank that for whatever reason defaults to UCP, or if the credit is a hybrid where documents like transport documents are involved.

Why do these rules matter? They matter because they fill in many details not spelled out in the credit/guarantee text. For example, none of the rules sets allow an issuing bank to refuse payment just because the applicant disputes the underlying contract – this principle of independence is reinforced. They specify the number of days a bank has to check documents (UCP and URDG give 5 banking days, ISP 98 says a “reasonable time not to exceed 7 days”). They outline what happens if a presentation is on the last day and the bank finds a discrepancy (can it approach the applicant for a waiver, etc.). They also cover things like force majeure – if a bank is unable to operate due to war or natural disaster as expiry hits, UCP 600 and ISP 98 have provisions to extend deadlines. Without such rules, one would have to explicitly include such conditions in every SBLC, which would be cumbersome.

Moreover, using a globally accepted rule set ensures that if a dispute goes to court or arbitration, the interpretation will refer to those rules rather than purely domestic law. Courts in many countries uphold ICC rules as part of the contract. This predictability is crucial in international finance.

Compliance and Regulatory Considerations: While the ICC rules govern the relationship and duties among banks and between bank and beneficiary, SBLCs and guarantees also must comply with mandatory laws. For instance, banks must follow sanctions regulations, anti-money laundering (AML) laws, and export/import controls. If a transaction or a party is sanctioned, a bank may be legally prohibited from paying, even if the SBLC rules say it should honor a complying demand. The rules typically include carve-outs that they do not override force of law. Also, banks have internal compliance checks when issuing or advising SBLCs (screening the names of parties, ensuring the purpose is legitimate and not money-laundering, etc.). From a user perspective, this means one should allow time for the bank’s compliance procedures when requesting an SBLC. Ensure the underlying deal is clean and well-documented to the bank, to avoid delays or refusals on compliance grounds.

Key takeaway on rules: Always specify in the text of the SBLC or guarantee which rules apply (e.g., “This SBLC is subject to ISP98 (ICC Publ. 590)” or “…subject to UCP600 (ICC Publ. 600)” or for guarantees “…subject to URDG758”). If you receive an SBLC/guarantee without such reference, it’s advisable to request an amendment to include a rule set. Otherwise, you may fall back on local law, which might be less favorable or simply less clear on certain issues (for instance, how long can a bank wait before deciding a demand is compliant? ICC rules give a firm answer; local law might not).

In summary, UCP 600, ISP 98, and URDG 758 are pillars of international trade finance practice. They each have a specific scope but share the goal of harmonizing and simplifying the process. A sophisticated businessperson dealing with SBLCs should have at least a passing familiarity with these acronyms:

• UCP 600 – the default rules for documentary credits, sometimes used for SBLCs.
• ISP 98 – the specialized rules just for standbys (often the best choice for standbys).
• URDG 758 – the rules for demand guarantees, making them as reliable internationally as LCs.

By using these rules, parties on all sides gain confidence that the standby or guarantee will operate smoothly, and any issues can be resolved by reference to a known framework rather than reinventing the wheel for each transaction.

Advantages of Using Standby Letters of Credit

Standby letters of credit offer several key advantages as a risk management tool in business transactions. We have touched on many of these points throughout the discussion, but here we consolidate the primary benefits that make SBLCs attractive for both parties in a contract:

• Assurance of Contract Performance: An SBLC provides a guarantee of timely and proper fulfillment of obligations under a contract (Резервный аккредитив (SBLC): финансирование и банковские кредиты). The beneficiary (e.g., seller or project owner) is assured that if the other party fails to perform or pay, they can recover the contract amount (or a stipulated compensation) by drawing on the SBLC. This safety net can be crucial in contracts where performance is critical, or the value is high.
• Reduced Counterparty Risk: By tying payment to document presentation, SBLCs nearly eliminate the risk of non-payment or non-performance by the applicant (Резервный аккредитив (SBLC): финансирование и банковские кредиты). The applicant cannot simply refuse to pay when due without consequence – the bank will pay in that case. This makes the transaction as secure as the credit of the issuing bank. For the applicant, having an SBLC may also allow them to enter deals that require security without having to pay in advance or post a cash deposit directly to the beneficiary. It spreads trust by leveraging the bank’s credit.
• Benefit to Both Parties: Both sides gain something. The beneficiary gets a guarantee of payment/performance, and the applicant in turn might negotiate better terms or prices due to providing that guarantee. For example, a buyer who provides an SBLC, might convince a seller to offer net 60-day payment terms instead of demanding cash on delivery, which improves the buyer’s cash flow. The seller feels safe granting credit because of the SBLC. Thus, SBLCs can help business negotiations by aligning interests with a secure framework.
• Conditional Payment Tied to Documents: Payments or compensation under an SBLC are tied to the presentation of specific documents (Резервный аккредитив (SBLC): финансирование и банковские кредиты). This means there is clarity on what constitutes a default and what is needed to prove it. For instance, a standby can be set so that payment is only made if an independent inspector certifies that certain milestones weren’t met, etc. This conditional structure protects the applicant from wrongful calls (beneficiary can’t draw just because they want to; They must present the agreed evidence) and gives the beneficiary a clear recipe to follow to get paid if needed. It introduces discipline into the transaction – everyone knows what documents will be required long before any problem arises, which often motivates the applicant to avoid default and the beneficiary to keep records in order.
• Stronger Negotiating Position and Confidence: Having an SBLC in place means contract terms can be negotiated on the basis of secure backing. Parties can focus on performance and quality, rather than worrying constantly about credit risk. It effectively builds trust: even if the buyer and seller are new to each other, the presence of the SBLC from a known bank lends credibility. This can open doors to new partnerships and markets, as mentioned earlier.
• SWIFT and Global Reach: SBLCs utilize the banking system’s infrastructure,like SWIFT, for issuance and communication, ensuring fast and secure transmission of the credit to anywhere in the world. Over 11,000 banks and institutions globally are connected via SWIFT, so an SBLC can be advised and confirmed across continents within hours (Stand-by Letter of Credit (SBLC): financing services and bank loans). This global network means that a beneficiary in one country can rely on an SBLC issued halfway around the world, often confirmed by a local bank for extra assurance, making international trade far more secure and efficient than it would be otherwise. The use of standardized SWIFT messages for LCs (MT7xx series) also reduces errors and ambiguities.
• Compliance with International Norms: The use of SBLCs (subject to ICC rules) ensures the deal’s security mechanism is in line with international norms and standards (Stand-by Letter of Credit (SBLC): financing services and bank loans). This can be important for regulatory or internal governance reasons. For example, an international development project might require any guarantees to be in the form of SBLCs or URDG guarantees to ensure uniform enforceability. Both parties know that the instrument is tried-and-true in international commerce.
• Flexibility and Customization: SBLCs can be tailored to various needs – they can be made transferable, allow partial drawings, be denominated in different currencies, have validities matching the project timeline, and include custom conditions. While one shouldn’t overcomplicate an SBLC, that flexibility can adapt it to many situations. Also, SBLCs can be “evergreen” (automatically extend annually unless notice of cancellation is given) which is useful for open-ended obligations like maintenance periods. Evergreen clauses protect beneficiaries from inadvertently losing coverage because they ensure the SBLC stays active until the issuer explicitly indicates non-renewal (usually with a lead time that gives the beneficiary a chance to draw if no replacement is provided).
• Improved Credit Terms: For applicants, providing an SBLC may allow them to avoid prepayments or large deposits. Instead of paying a supplier upfront or a contractor providing a huge retention money, they can use an SBLC to cover the risk. This keeps their cash free for working capital while still satisfying the other party’s need for security. Essentially, the bank’s involvement temporarily supplements the applicant’s credit capacity, which can help companies take on bigger projects or orders than their standalone credit would permit.
• Peace of Mind in High-Risk Deals: In projects subject to high risk (be it political risk, performance risk, etc.), SBLCs bring peace of mind. Knowing that funds are guaranteed in worst-case scenarios lets businesses plan and execute projects without the constant fear of catastrophic loss due to partner default. This psychological and practical safety net often justifies the costs involved.

To illustrate the advantages for each side, consider the perspectives of a buyer vs a seller in a trade with an SBLC:

• Advantages for the Buyer (Applicant): They can receive goods without having to prepay, or with deferred payment terms, because the seller is protected by the SBLC. The buyer effectively gets credit – often using the issuing bank’s funds temporarily if the SBLC is drawn, since the bank will pay and then the buyer reimburses later (Stand-by Letter of Credit (SBLC): financing services and bank loans). It also allows the buyer to demonstrate financial credibility (even if the buyer is small or relatively unknown, a reputable bank’s SBLC makes them appear trustworthy). If the buyer meets all obligations, the SBLC costs are just fees, and no impact on cash (besides perhaps a margin/collateral if required by the bank). Additionally, if a dispute arises, the buyer can’t be unfairly blackmailed by a seller threatening not to ship – because the seller knows if they don’t perform, they won’t get paid (in a documentary LC scenario) or they can’t just draw money unless there’s a real default (in an SBLC scenario). This mutual accountability can keep both parties honest.
• Advantages for the Seller (Beneficiary): They can ship goods or undertake a project with a 100% guarantee of payment (either from the buyer or from the SBLC) (Stand-by Letter of Credit (SBLC): financing services and bank loans). In case the buyer fails to pay or perform, the seller gets paid promptly under the SBLC, which greatly improves their cash flow certainty. The seller effectively has double assurance – the buyer’s promise and the bank’s guarantee (Stand-by Letter of Credit (SBLC): financing services and bank loans). This allows the seller to potentially offer better prices or extended terms, knowing their risk of non-payment is low. The seller can also potentially use the SBLC to get financing (e.g., show it to their bank to discount the receivable or use it as collateral). Furthermore, having an SBLC, might allow the seller to increase volumes or enter new markets with competitive payment terms, giving them a competitive edge (since they can safely offer credit where others might insist on advance payment) (Stand-by Letter of Credit (SBLC): financing services and bank loans).

A quick recap of a few concrete benefits that were listed in the earlier table context (Stand-by Letter of Credit (SBLC): financing services and bank loans) (Stand-by Letter of Credit (SBLC): financing services and bank loans):

• The buyer gets goods without prepayment and possibly with a deferred payment period, yet the seller is guaranteed to be paid.
• If the buyer momentarily cannot pay on the due date, the issuing bank’s funds cover the gap (so the seller still gets paid on time, and the buyer essentially borrows from the bank for that interval).
• The seller has the confidence to increase supply volume or enter new markets because the risk of not getting paid is mitigated.
• If the contract is fulfilled successfully, the SBLC can even be canceled early by agreement, ending the arrangement once it’s no longer needed (Stand-by Letter of Credit (SBLC): financing services and bank loans) (freeing up the applicant’s credit line potentially).

Conclusion – Leverage of SBLC: By deploying standby letters of credit, companies achieve a strong balance of security and flexibility. These instruments underpin trust in large-scale and international transactions and are a cornerstone of trade finance. The practical guidance for businesses is: use SBLCs (or similar bank-guarantee instruments) when the potential loss from counterparty default is too high to bear, or when such a guarantee is required to make the deal happen. Ensure to work with your bank to word the SBLC appropriately for the situation, choose the right governing rules (ISP/UCP), and clarify the requirements for any draw. With these precautions, an SBLC can greatly facilitate commerce by reconciling the needs of both cautious sellers and credit-seeking buyers.

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Frequently Asked Questions (FAQs):

Q: How do I obtain an SBLC from a bank?
A: Typically, you must have a banking relationship or credit line established. You’ll apply for an SBLC much like a loan. The bank will underwrite the request – assessing your creditworthiness, possibly requiring collateral or a cash margin, and will charge fees as discussed. Once approved, the bank will issue the SBLC text in coordination with you and (sometimes) the beneficiary to ensure it meets contract requirements. This process can take a few days to a couple of weeks, depending on due diligence and negotiation of terms.

Q: Is an SBLC always irrevocable?
A: Yes, practically all standby letters of credit are issued as irrevocable. Under UCP 600, credits are irrevocable unless stated otherwise (and revocable credits are now exceedingly rare). Under ISP 98, the concept of revocable isn’t really applicable – standbys are assumed to be firm commitments. So you should consider any SBLC irrevocable once issued (until its expiry or allowed cancellation).

Q: Can the SBLC be extended or increased if needed?
A: Yes, the applicant can request an amendment from the issuing bank to extend the validity or increase the amount (for example, if the underlying contract value goes up or project is delayed). However, amendments require beneficiary consent as well to become effective. Many SBLCs for project performance have built-in buffers so they don’t need frequent amendments (or use evergreen clauses). Always monitor the expiry date and draw conditions; if an extension is needed, coordinate well in advance with all parties.

Q: What if an unjustified demand is made under an SBLC?
A: Banks will pay if documents appear on their face to comply, so they won’t judge the underlying fairness. If a beneficiary calls an SBLC in bad faith (say, falsely claiming breach), the applicant may need to seek an injunction in a court to stop the payment. Courts can issue injunctions in cases of proven fraud or abuse, but it’s a high bar (this is known as the “fraud exception” to the independence principle). In most honest transactions, this is not an issue. Properly wording the SBLC with objective conditions can prevent gray areas. Using URDG 758 or ISP 98 can also incorporate wording that discourages abusive or frivolous calls.

Q: SBLC vs. Guarantee – which should I choose?
A: It depends on context. If dealing with U.S. banks or companies, SBLC is usually the way to go, as it’s standard for them. In other regions, either is fine, but consider using whichever instrument your bank is most familiar with and can process efficiently. If you want the backing of ICC rules in either case, you can use SBLC with ISP98 or guarantee with URDG758 – both will be equivalently robust. Sometimes the decision is made for you by tender requirements or market norms. If a counterparty specifically asks for an SBLC, you provide an SBLC (and vice versa). When given the choice, SBLCs through a bank’s trade finance department can be straightforward, whereas some banks treat guarantees slightly differently. Consult with your bank on what they can offer for your needs.

Q: Does having an SBLC mean I don’t need insurance or other safeguards?
A: An SBLC covers a specific counterparty risk (typically credit risk of non-payment or performance). It doesn’t replace other risk management tools. You might still need marine insurance for goods, political risk insurance if dealing with unstable countries (an SBLC won’t pay if say war breaks out unless that caused a contractual default that is claimable), and you should still perform due diligence on partners. Also, an SBLC is only as good as the bank behind it – so ensure the issuing bank is reputable or get the SBLC confirmed by a stronger bank if there’s any doubt.

By understanding and utilizing standby letters of credit effectively, businesses can significantly enhance the security of their transactions while maintaining the flexibility needed for growth and collaboration. SBLCs, when structured properly, truly embody the principle of “hope for the best, but prepare for the worst,” enabling commerce to flourish even in uncertain conditions.