A standby letter of credit is a guarantee of payment issued by a bank or a financial institution on behalf of client where the bank or a financial institution promises to pay a "beneficiary" in case of default by the applicant.

Historically, Standby letters of credit were developed because the US regulator legally limited bank or a financial institution US bank's authority to issue guarantees.

A stand-by letter of credit is a very flexible financial tool, making it a suitable instrument for securing a vast range of payment scenarios.

It is commonly used for international trading as it provides assurance to the seller / exporter that the payment will come through. However, a stand-by letter of credit involves quite a few complexities and therefore, one must consult with an expert if not well acquainted with stand-by letters of credit.

Types of Stand-by Letters of Credit

Performance standby letter of credit
Advance-payment standby letter of credit
Bid-bond or tender-bond standby letter of credit
Counter standby letter of credit
Financial standby letter of credit
Insurance standby letter of credit
Commercial standby letter of credit
Direct-pay standby letter of credit


Guarantees can be either direct or indirect:

A direct guarantee – when a bank is instructed to issue a guarantee by its account holder, in favour of the beneficiary. A direct guarantee is when a bank is instructed to issue a bank guarantee by its account holder in favour of the beneficiary.

An indirect guarantee – is when a second bank is asked to issue a guarantee in return for a counter guarantee. In case the second bank suffers losses in the event of claim against the guarantee, the issuing bank indemnifies any losses the second bank suffers.

Several Types of BG:

Bid Bond
Performance Bond
Advance Payment Guarantee
Warranty Bond
Letter of Indemnity (LOI)
Payment Guarantee
Rental Guarantee
Confirmed Payment Order

The bank's guarantee to pay may be subject to conditions which stipulate that the bank shall be obligated to pay the beneficiary the a fixed promised amount on behalf of its client if the conditions are fulfilled.