A standby letter of credit is the guarantee provided by the issuer bank or financial institution that the responsibility of payment will be transferred upon the non-payment of the party to the contract.
In this type of instrument, the issuing bank will have to follow all the banking protocols followed by the bank.
However, in the case of a bank guarantee the bank assures the full payment to the lender in case of failure by the debtor. In other words, in case of failure by the debtor, the bank will always be there to help and recover the debt.
These instruments cover the risks of both parties to the contract that is the supplier to the contract by ensuring the full payment when agrees to provide the goods as per the description of the purchase order, this also ensures the buyer to the contract while ensuring delivery of goods as per the terms and conditions of the contract and delivery of high-quality goods.
The main purpose of the standby letter of credit is to provide a fair business opportunity and to facilitate boundaryless business transactions.
This also enhances the credibility of international trade and also motivates new customers to enter into international trade.
With the help of these instruments, the business entities in the world can take maximum benefit by importing the scarce resources and exporting the abundant resources of the country.
This type of instrument is created upon the strict regulations placed by the US regulatory authorities on the banks.
However, the purpose of the bank guarantee is to make a promise from a lending institution that ensures a bank will step if the debtor cannot recover the debt. These instruments assure the safeguard of the rights of both parties to the contract.
These instruments also act as a source of increasing the competition among the different economies around the globe. Due to increased in such competition the dealing of the goods is undertaken at quite a fair price.
There are many types of standby letters of credit such as A direct pay standby, A performance standby, A bid bond or tender bond standby, Advance bond standby, financial standby, commercial standby, counter standby, and insurance standby.
Like any other instruments, these differ when the terms and conditions of the instrument change.
For example, a financial standby letter of credit is an irrevocable instrument that ensures the hundred percent payment to the affected parties in case of default, a performance standby letter of credit refers to the instrument which promises to pay fifty percent of the defaulted amount to the affected party in case of default, insurance standby refers to the insurance and reinsurance of the applicant, commercial standby is the instruments pay for goods in case of failure in payment as per the agreed terms and a bid or tender standby supports the obligation of the applicant to execute a contract if the applicant is awarded a bid.
There are also different types of bank guarantees such as direct bank guarantees and indirect bank guarantees.
The main difference between these two types of instruments is that the direct bank guarantee is provided by the account holder of the bank however indirect bank guarantee is provided by any other bank.
A standby letter of credit, as well as a bank guarantee, are the prime facilitators of international trade like many other instruments. It secures the risk involved in the business transaction that settles across the border of the world.
Due to these instruments, an economic resource can be shared with the economies where such resources are scarce at a competitive price.
This can also able to increase the income of the country where these resources are abundant by selling them to another economy where there is a need for such resources in order to fulfill the economic needs of such countries.
Thus, it is beneficial for the individual business entities as well as the economy, it increases the income of individuals and the economy at the same time and it also fulfills the economic needs of the other countries of the world.
There is a huge difference between the standby letter of credit and the bank guarantee, a bank guarantee is an obligation the circumstances of which is the civil procedures however the standby letter of credit of any type follows all the banking protocols.
This is why the standby letter of credit is considered a more secure form of contract than a bank guarantee.