A standby letter of credit (SLOC) is a guarantee of payment by a bank on behalf of their client. It is a loan of last resort in which the bank fulfills payment obligations by the end of the contract if their client cannot. The standby letter of credit is never meant to be used, but prevents contracts from going unfulfilled in the event your company closes down, declares bankruptcy, or is unable to pay for goods or services provided. Standby letters of credit help prove a business’ credit quality and repayment abilities.
Types of Standby Letters of Credit
- Performance standby letters of credit ensure the nonfinancial contractual obligations (quality of work, amount of work, time, cost, etc.) are performed in a timely and satisfactory manner. If these obligations are not met, the bank will pay the third party in full.
- Financial standby letters of credit ensure financial contractual obligations are fulfilled. Most SLOCs are financial.
- Financial SLOCs are often required when performing international trade or other large purchase contracts under which other forms of payment protections (such as litigation in the event of non-payment) can be difficult to obtain.
How to Obtain a Standby Letter of Credit
The standby letter of credit process is similar to that of obtaining a commercial loan, with a few key differences. As with any business loan, you will need to provide proof of your creditworthiness to the bank. However, the SLOC approval process is much quicker, with letters often being issued within a week of all paperwork being submitted. Unlike traditional loans, the bank will require a standby of letter of credit fee of between 1-10% of the SLOC amount before issuing the letter. This fee is usually charged per year that the letter of credit is in effect. If the terms of the contract are fulfilled early, you can cancel the SLOC without incurring additional charges. Standby letters of credit can help establish trust with your business partners and be a powerful tool to help meet your business goals. Talk with your banker about how you can use a standby letter of credit for your business.