Standby letter of credit

Parties and how it works

The Standby Letter of Credit – also Parties

At least three parties are involved in a Standby LC:
"Standby LC" – serves to secure payment
and performance obligations.

It has its roots in American banking law and is used mainly in

international business with American states, as well as in the
Far East. Principal
Upon the contractual partner's request, it instructs its bank to
In contrast to a guarantee, a Standby LC may be confirmed open a Standby LC to secure its payment or performance
under certain circumstances. In the following, it is treated as a obligation.
guarantee.

The Standby LC is based on a contract between two business

partners.

Beneficiary
It's entitled to draw under the Standby LC if the principal fails
to provide a service or make a payment. In this case, the
guaranteeing bank has to pay.

Principal's bank
It issues the Standby LC and forwards it to the beneficiary.
This can be carried out via an "advising" bank – generally, the
beneficiary's bank.

Advising/confirming bank
In most cases, it's located at the beneficiary's domicile. It
examines the apparent authenticity of the Standby LC and
advises it to the beneficiary. It takes on no obligation.

If permitted by the terms of the Standby LC, it can also be

confirmed by the advising bank. In this case, it's liable for the
Standby LC and assumes the credit risk and the country risk,
which is a benefit for the beneficiary.

UBS, Standby letter of credit. Also available in German and French. February 2016, 84512E Page 1of 2
How it works 4a. Advising Standby LC
Let's have a look at how a Standby LC is opened taking the The advising bank examines the apparent authenticity of the
example of securing payment. Standby LC and forwards it to the supplier.

1. Underlying transaction
A Swiss supplier and a buyer in the USA conclude a contract
over an underlying transaction – for example, the purchase of
a gas turbine. The supplier requests a Standby LC as a
payment guarantee.
2. Order
The buyer instructs its bank to open a Standby LC with the
supplier as the beneficiary.
3. Opening of Standby LC
The principal's bank opens the Standby LC and transmits it to
the beneficiary. It can also be sent via an advising bank.
The underlying transaction is settled. The advising bank takes
on no obligation in this case: the supplier bears the credit risk
and the country risk.
4b. Confirmation and advising Standby L/C
If the supplier wants to limit these risks, it asks the buyer to
open a Standby LC with confirmation from the advising bank.
The confirming bank therefore takes on its own payment
obligation irrespective of the opening bank's obligation. Both
the credit risk of the principal's bank and the risk of the
importing country are therefore covered.
The bank sends the confirmed Standby LC to the supplier. The
underlying transaction is settled.

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UBS, Standby letter of credit. Also available in German and French. February 2016, 84512E Page 2 of 2