What is the different between letter of credit and standby letter of credit?
A letter of credit is used as a method to facilitate payment of
international trade transactions (ie: the import/export of
Unlike a trade letter of credit, a standby letter of credit is NOT
meant to be used for payment. A standby letter of credit is used as
a form of "back-up" guarantee (hence the name "standby") used for a
variety of purposes.
There are two types of standby letters of credit: Performance
Standby L.C. and Financial Standby L.C.
Performance Standby's are used to guarantee some sort of
performance of a contractual obligation. For example, a
construction company building a highway bridge might be required by
the highway department to put up a performance standby letter of
credit ensuring that they will complete the project contracted or
to warranty the work. Under normal circumstances the standby would
not be drawn upon, however if the contractor abandoned the project
midway through completion or if the bridge were unsafe, the standby
letter of credit could be drawn upon for its specified dollar
A Financial Standby Letter of Credit is similar in concept to the
Performance Standby, but instead acts as a guarantee for payment of
For example, companies trading on securities markets are frequently
required to have financial standbys in place benefiting the
particular stock market exchange which can be drawn upon if they
are for whatever reason unable to settle their trades at the end of
Financial standby's can also be used in international trade, but in
a different manner than standard letters of credit.
Normal trade letters of credit are intended to be used for
pre-specified shipment(s) of goods or services. The letter of
credit requires documents specifically evidencing the trade
transaction itself and the letter of credit serves as the vehicle
for payment of the trade transaction.
When financial standby's are used for trade purposes, they are not
intended as a means of payment, but as with all standby's, act as a
Financial standbys frequently are used between buyers and sellers
who have frequent, ongoing trade shipments for an extended period
of time. The standby acts as a blanket guarantee for the overall
obligations of the buyer to pay and does not contains specifics
related to any one particular shipment.