STANDBY LETTER OF CREDIT

 A standby letter of credit can add credibility to its bid for a project, businesses can have difficulty competing against bigger and better-known rivals. The standby letter of credit is often seen in contracts involving international trade, which tend to involve a large commitment of money and have added risks.

For the business that is presented with a standby letter of credit , the greatest advantage is the potential ease of getting out of that worst-case scenario. If an agreement calls for payment within 30 days of delivery and the payment is not made, the company can present the standby letter of credit to the buyer's bank for payment. If a contract calls for construction of a building and the builder fails to deliver, the client presents the standby letter of credit to the bank to be made whole.

A standby letter of credit is a bank's commitment of payment to a third party in the event that the bank's client defaults on an agreement. It is a "standby" agreement because the bank will have to pay only in a worst-case scenario. A standby letter of credit is most often sought by a business to help it obtain a contract.

A financial standby letter of credit guarantees payment for goods or services as specified by an agreement. An oil refining company, for example, might arrange for such a letter to reassure a seller of crude oil that it can pay for a huge delivery of crude oil. The performance standby letter of credit , which is less common, guarantees that the client will complete the project outlined in a contract. The bank agrees to reimburse the third party in the event that its client fails to complete the project.