In global trades, SBLC (Standby Letter of Credit) plays an important role in facilitating transactions. SBLCs are financial instruments that have been issued by FIUs (financial institution units) or banks. It serves as a payment guarantee to the beneficiary if the other party fails to pay after getting the products or services.
The financial institute not only makes the payment to the beneficiary only when the bank fails to do it but also if the seller completes all the documents then the bank is required to pay immediately. Generally, the document type is used by the parties who have made their first deal and they don’t know each other.
In this post, we will delve more into the benefits and risks associated with the SBLC monetization process.
Key characteristics of SBLCs are:
Global Acceptance: The document can be served globally in international trade.
Payment assurance: Seller receives appropriate payment even if the buyer fails to do it.
Types of Standby Letters of Credit!
Revolving letter of credit: It is a credit that renews automatically even when the original amount is drawn which results in continuous funding.
Advance payment: This type of SBLC document is used to secure payment to sellers so they receive funds before all the obligations are fulfilled.
Financial SBLC: As its name indicates, it involves the payment security as mentioned in the contract within specific timeframe. For example:
if a buyer is expecting to receive money within one month after receiving goods from the oil company but the buyer fails to do it then the oil company can collect the payment from the bank directly.
Benefits of SBLCs
Security: Security provided to both the involved parties buyer and seller is its prime advantage. Therefore, they get ready to make a deal without worrying about the payment issues.
Additionally, when the seller has the confidence of receiving a full amount then they can easily borrow money to complete the deal.
Leased SBLC monetization: One can get liquidity by Leasing SBLC.
Financial responsibility: The Issuing bank of SBLC assumes that the buyer is ultimately financially responsible for the payment.
Customization: The terms can be customized according to the preferences of involved parties in international trade. The amount, time, or set of terms can be personalized.
Disadvantages of SBLC
While an SBLC provides multiple benefits to the applicant it also comes with various risks. Here, we have discussed a few:
Complexity of the process: SBLCs are complex financial documents that require attention to detail to execute properly. Obtaining an SBLC adds up the cost of the transaction and sometimes it is the reason behind the potential transaction delays. The process requires complete documentation and sometimes a lot of waiting period.
Cover single transaction: If you are required to do multiple transactions then you can’t rely on a single Standby Letter of Credit. It covers only a single transaction for a single buyer therefore for each transaction; you will require an additional Standby Letter of credit.
Time-consuming and costly: The process is expensive, time-consuming, and daunting in various ways from paying the charges to gathering all the documents.
Require an additional layer of security: It requires an additional layer of security and collateral to satisfy the coverage requirements of the bank for the buyer.
Lengthy process: The process of obtaining SBLC is quite lengthy and laborious which involves a lot of paperwork and much more.
Fraud or misuse: These documents are also vulnerable to misuse that can cause significant harm to both the involved parties. Sometimes, the document is issued to the client who has no intention to follow the obligation resulting in the loss of the other party.
Benefits for the applicant
An applicant can secure a bid or deal with ease using the document. The document shows the creditworthiness of the buyer party. By checking SBLC, it becomes easier for the seller to believe in the other party for the success of a deal.
Additionally, an SBLC document helps the applicant negotiate better terms and conditions like longer payment periods, low interest rates, and so on. Therefore, the applicant can get the terms and conditions in his/her favor.
Benefits for the beneficiary
SBLC provides a high level of assurance and protection if the buyer party fails to follow the obligations stipulated in the contract. The Seller party can make a direct claim from the bank.
Additionally, it reduces the chances of political instability and legal disputes that can affect the transaction.
Other benefits include:
The bank can assign, transfer, or confirm an SBLC according to the beneficiary's requirements and needs.
Risks for the beneficiary
SBLCs can provide a great level of confidence and security but there are always some limitations associated. What if the financial institution or bank becomes insolvent and fails to pay the amount? This can happen when a bank struggles with liquidity issues, regulatory problems, and other issues.
Secondly, beneficiaries have to wait for longer to get payment or they might also face issues in verifying the documents that are required for SBLC payment especially if there is some problem associated with the documents like incorrect or incomplete.
Risks for the applicant
One of the main risks is that the applicant might lose his/her money in case if the beneficiary party made a demand from the financial institution by using a wrongful or fraudulent activity. Sometimes, the buyer party breaches the contract causing a dispute over the quality and included goods and services.
Another risk that applicants can face is struggling to renew their SBLC document especially if the credit rating of the applicant falls.
Conclusion!
Ultimately, SBLC plays an important role in facilitating the international trade providing payment guarantee to the beneficiary if the buyer fails to follow the contract or obligations. The benefits associated with SBLCs are reduced risk, access to the international market, enhanced creditworthiness, and so on. One needs to assess the benefits and risks associated with making the final decision. However, make sure you choose only the right SBLC monetization provider.