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Under construction - January 7th, 2006. Click on Refresh to see updates as they are being created. Standby Letter of Credit (SLC):
A Standby Letter of Credit is a form of insurance on an underlying agreement or obligation (contract), insuring all parties to the contract against failure to perform or pay on the part of one or another party to the contract. Standbys are issued by banks.
There two basic categories of Standby Letters of Credit: Commercial and Financial. The Financial Standby is the one most often used by swindlers in such a convoluted manner as to make it nearly impossible to explain the scams short of providing an entire course in credit finance.
Both type of Standby pose a risk to the issuer - the bank. As with any insurance, there is the potential for loss and the requirement for the bank to make good on the loss. In other words, the bank is gambling that it will make money on the transaction in the form of fees, not make a payout; therefore, Standby Letters of Credit are not issued casually, and the creditworthiness of the applicant, the pertaining documents, and the underlying contract are examined prior to approval.
Other types of Standby include Direct Pay Standby, Advance Pay Standby, Bid Bond Standby, and Counter Standby.
Commercial Standbys:
A Commercial or Performance Standby Letter of Credit is an irrevocable commitment [undertaking] on the part of a bank to guarantee performance in an underlying contract between a Buyer and Seller or a service provider.
This type of Standby can be used to insure many types of transactions from international trade to buying or selling a house or other major purchase.
The Standby stands as a guarantee that the parties to an underlying contract will perform as agreed. Used in this matter, the Standby serves as a PERFORMANCE BOND and may be called a Performance Standby Letter of Credit.
As such, it is an "off the books" instrument because, until there is a default that causes the Standby to be executed (called upon), there really is nothing to ledger other than the fee charged by the bank for agreeing to the Standby and creating it. Neither the bank nor the bank's customer ever expect the credit to be needed, but it's there to cover unforeseen circumstances.
Financial Standby
The "Financial" Standby Letter of Credit, also known as CREDIT ENHANCEMENT depending on its use, serves a different purpose than the Commercial Standby, albeit they do have a few things in common inasmuch as each is used as a form of quasi-insurance.
The difference is that whereas the Commercial/Performance Standby Letter of Credit backs an obligation to perform an action, the Financial Standby Letter of Credit backs an obligation to pay money or repay a loan.
For instance, if the Buyer fails to make an obligated payment for a delivery of product or service, the Financial Standby Letter of Credit kicks in and the Seller or service provider is paid.
Again, neither the bank nor the applicant ever expect the Standby to be called upon.
If the Financial Standby is being used to safeguard a portfolio while the portfolio owner seeks alternate credit lines, then the portfolio or other liquid assets (depending on bank negotiations) must be used as the collateral for the Standby, and a minimum value of the collateral must be maintained. If the value of the collateral falls below the minimum, the bank can liquidate the owner's assets or call upon the owner to make up the difference.
It's easy to find definitions and applications for Standby Letters of Credit on the Internet, but it can be very confusing. The International Chamber of Commerce book, International Standby Practices ISP98, is the definitive book for Uniform Custom and Practice governing Standby.
It's a short booklet, only 76 pages and a mere 8-1/2 by 8-1/2 inches, and is written in legalese. Conditions abound - what to do under these circumstances, what to do in that situation - teeming with phrases such as "A claimed successor may be treated as if it were an authorized transferee of a beneficiary's drawing rights in their entirety if it presents an additional document or documents which appear to be issued by a public official or representative ..." © 1998, Institute of International Banking Law & Practice, Inc., International Chamber of Commerce ICC Publication No. 590, International Standby Practices ISP98, page 49.
The confusion and misunderstanding by the general public about Standbys make the term a perfect tool for con artists, particularly as Standbys can be applied to CREDIT ENHANCEMENT.
Additional information: Federal Reserve: Financial Standby Letters of Credit and Performance Standby Letters of Credit, March 30, 1995. Intrust Bank: Standby Letters of Credit
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