Text 2 Standby Credits

• Standby credits can be used instead of advance payment bonds or guarantees progress payment bonds, performance bonds or retention monies bonds. This aspect of standby credits will be referred to later in the text.

• Standby credits can also be used when a bank w reluctant to grant much more credit to the customer because the customer is near his credit limit with the bank already.

Let's look at this second use of standby credits a bit more closely.

Standby credits can be used to provide security of payment to suppliers who sell goods abroad on D/A terms in the event that a foreign buyer accepts a bill of exchange and obtains the documents and the goods, but subsequently refuses to pay the accepted bill. With D/A collections, the presenting bank can be asked to protest for non-acceptance or non-payment of a bill, but this is of limited comfort to the exporter who will have lost control over the goods.

The exporter could insist on different payment terms - ie 'ordinary' irrevocable letters of credit - but the buyer might be unable to arrange credit facilities from his bank for the letters of credit, because the bank is reluctant to grant him more credit.

In such a situation, a suitable arrangement might be for a standby letter of credit to be issued at the request of the buyer and in favour of the exporter, providing a guarantee of payment by the issuing bank in the event that the buyer, having arranged with an exporter for payment by means of documentary collection, accepts a bill of exchange but then dishonours it through non­payment.

An example might help to illustrate this use of standby credits.

Example

Suppose that a UK importer, UK Ltd, wants to buy goods from abroad, possibly on a regular basis, say once a month or once every two or three months. The foreign supplier wants payment for each shipment to be by means of an irrevocable letter of credit, with drafts drawn at 60 days' sight, say, on a UK bank.

A UK bank might agree to issue such letters of credit on behalf of UK Ltd, but suppose that UK Ltd already has quite a large amount of credit, so that the bank might have second thoughts about extending the company much more.

An alternative solution to the problem would be to:

(a) persuade the foreign supplier to agree to a documentary collection as the method of payment for each shipment, with drafts drawn at 60 days' sight on UK Ltd. In this way, UK Ltd could take 60 days credit for each shipment from the supplier, and would not be using any credit facilities from the bank. The company would be taking trade credit from the supplier;

(b) satisfy the foreign supplier's requirement for a secure method of payment (ie letters of credit drawn on a UK bank) by issuing a standby letter of credit in favour of the supplier. This would be a guarantee of payment by the issuing bank in the event that UK Ltd dishonoured one of its bills.

A standby letter of credit would be issued for a fixed term, typically one year, and

(a) would cover a series of shipments in this time, but

(b) would be for a specific maximum value - say, covering one or two shipments.

Another example of standby credits would be as follows.

A buyer might receive regular shipments from a supplier and pay on open-account creditterms. However, the supplier might ask the buyer to arrange a standby credit in his favour, in case of default on a payment. If the buyer does default, the supplier would be expected to present

• an invoice and

• a signed statement that payment has not been received within a stated time after the due date of payment

• a copy of the certificate of shipment covering each consignment shipped.

The supplier would present these documents in order to claim payment under the standby letter of credit. The credit would only be used if the buyer defaults on payment under the normal arrangements.

In summary:

• Standby letters of credit provide security to the exporter, and at the same time reduce the total amount of bank credit required by the buyer (the applicant for the credit).

• They can act as a standby guarantee for trade conducted on other payment terms (documentary collection with bills drawn on the buyer, not the bank).

• When the standby letter of credit is invoked, the beneficiary will be able to draw bills on the issuing bank.

• Standby letters of credit are covered by the Uniform Customs and Practice for Documentary Credits.

Reinstatement letters of credit

Banking practice is constantly changing, and reinstatement letters of credit have emerged as an alternative to standby letters of credit, for situations where:

(a) an importer receives regular shipments from abroad, perhaps monthly shipments from a foreign supplier;

(b) the supplier insists on payment by means of a letter of credit;

(c) the bank is unwilling to issue a letter of credit for the full value of shipments over a number of months, because the importer's credit facilities with the bank are already nearly fully utilised, or because the bank is unwilling to grant the customer such large facilities.