A Letter of Credit (LOC) is used to protect the interests of both buyer and seller in an international transaction. This documentation guarantees that a buyer will make the appropriate payment to a seller in a timely manner, while also making certain that the supplier (seller) does not receive payment until the issuing bank receives a confirmation, informing all parties that the merchandise has been sent.
The letter allows for the credit of the issuing bank to substitute on the client’s behalf in the event that the buyer is not able to make payment. In this situation, the letter of credit ensures that the issuing bank will be responsible for paying the remaining amount and reduces common risks involved with international trading/transactions.
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Stand-by Letter of Credit
A Commercial Letter of Credit is taken as Guarantee to be used in payment of goods and services. The Standby Letter of Credit issued is taken as guarantee that the applicant, the customer of issuing bank will execute responsibilities under an agreement. In other words, if an applicant fails to meet the promises made, the beneficiary draws on standby. According to the Controller of Currency, Standbys defined as, ‘any letter of credit or a similar document issued which mentions responsibilities to the beneficiary on the side of issuer.
The SBLC (Standby Letter of Credit) mentions details regarding-
1. To pay back the money borrowed or advanced to or for the account of the account party.
2. To pay on account of an indebtedness undertaken by the account party.
3. To pay in case of default by the account party in meeting of any promises made.
In the first condition, the bank which issues the SBLC agrees to pay back the money advanced or borrowed in case if applicant fails to pay. For example, a U.S. bank which offer finance to local unit of a foreign business may require SBLC payable to the bank from the foreign unit’s bank to bear the loan. In case, if local business fails to repay the loan, the U.S. bank rely on the standby to recover the unpaid loan amount.
The SBLC may also be used to guarantee the payment of invoices for sales made on open account. The purchasing party may request his bank to provide SBLC to the seller with the criterion that the Standby may be drawn on in case if outstanding bills amount are not paid within the asked time duration. If the purchasing party fails to pay on time and original invoice is unpaid, the seller has the complete authority to draw on the standby by presenting a draft, copies of the due invoices and letter with clear mention that invoices are due.
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