Standby Letters of Credit

Abstract

A standby credit provides a mechanism by which the beneficiary can claim a sum of money from a bank if the applicant defaults on its payment or contractual obligations. It provides the function of a demand guarantee but operates on the same basis as a letter of credit.

Whilst a legitimate and often used method to claim monies in a default situation, standby credits are vulnerable to abuse, fraud, money laundering and sanctions violation. They are often easy for the beneficiary to claim under and their potential for lack of transparency on the nature of the underlying transaction, and use of copy transport documentation can render the issuing bank vulnerable.

The importance of having visibility on the underlying transaction is highlighted and the optimum structure described when used with a new or untested beneficiary.