Improving the SMEs Access to Trade Finance DRAFT
in the OIC Member States
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B. Standby Letters of Credit
A Standby Letter of Credit is a written undertaking given by a bank (Issuing Bank), at the
request of an Applicant, which can be a bank, to provide assurance to a Beneficiary regarding
the Applicant’s (or a third party’s) performance or financial obligations, that promises to pay
the Beneficiary against presentation of a documentary demand conforming with the terms and
conditions specified in the letter of credit. Unlike a commercial letter of credit, which is
expected to be the means of payment in the underlying transaction, a standby letter of credit is
typically not drawn unless there is some manner of default in the underlying transaction. Such
credits are normally governed by the ICC rules (UCP or ISP 98).
(i) Standby Letters of Credit --- Risk Mitigation
a. Confirmed Standby Letter of Credit --- A Standby Letter of Credit in which the Issuing
Bank requests and nominates a second bank(often the Advising Bank) to add its undertaking
to the Standby Letter of Credit, in addition to that of the Issuing Bank, to honor a compliant
claim without recourse to the Beneficiary. Generally governed by ICC rules, such confirmation
provides additional comfort to the Beneficiary who wishes to mitigate the bank risk of the
Issuing Bank, or to credit enhance the undertaking of the Issuing Bank.
b. “Silently” Confirmed Standby Letter of Credit --- A Silent Confirmation is typically
undertaken at the request of the Beneficiary instead of the Issuing Bank. A silently confirming
bank undertakes to honor a compliant claim made under a Standby Letter of Credit. The Silent
Confirming Bank’s obligation is evidenced by a separate undertaking document which is
outside the terms of the Standby Letter of Credit and this distinct bilateral arrangement is not
covered by the ICC rules.
(ii) Standby Letters of Credit --- Categories
a. Performance Standby Letters of Credit (or Performance Bond) --- is issued to guarantee
performance of the Applicant (or a third party) under a contract. It is considered a show of
“good faith” and is not normally expected to be drawn upon. Advance Payment and Bid Bonds
are also generally considered to be similar in nature to Performance Bonds. Performance
standby LCs are related to underlying commercial trade transactions.
b. Financial Standby Letter of Credit --- is issued to guarantee future payment obligation(s).
The Financial Standby LC will only be drawn upon should the Applicant (or a third party) not
make the payment(s) as expected. This instrument may also be used in lieu of cash collateral.
Financial standby LCs are NOT related to underlying commercial trade transactions.
* Financial standby LCs may NOT be considered Trade products where there is no underlying
trade transaction.
(iii) Standby Letters of Credit – Special Characteristics
a. Evergreen Clause – Allows the letter of credit to be automatically extended until the issuing
bank informs the beneficiary of its final expiration date.