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What is the different between letter of credit and standby letter of credit?

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2009-10-25 01:41:49

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

financial obligations.

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

the day.

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

"back-up" guarantee.

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.

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