# Standby Letter of Credit (SLOC): Definition, Benefits, and Process

## What Is a Standby Letter of Credit (SLOC)?

When there are large projects in the works, some companies look for reassurance that their investment will be good. Enter a standby letter of credit (SLOC). This document, provided by a bank, guarantees that a sale or project will be completed as promised. The backing bank will only pay out in the event of a catastrophic failure.  

### Key Takeaways

*   A standby letter of credit is a bank's guarantee of payment to a third party if its client fails to fulfill a contractual obligation.
*   SLOCs are commonly used in international trade to mitigate the risks involved with large financial commitments between unfamiliar parties.
*   There are two types of SLOCs: financial, which ensures payment for goods or services, and performance, which guarantees project completion.
*   Obtaining a SLOC involves a process similar to applying for a loan, with the bank assessing the applicant's creditworthiness.
*   The cost of a SLOC typically ranges from 1% to 10% of the total guaranteed amount per year, acting as a protective measure for businesses.

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## Understanding the Mechanism of a Standby Letter of Credit

An SLOC is most often sought by a business to help it obtain a contract. The agreement is called "standby" because the bank pays only if the buyer defaults. An SBLC guarantees payment, but the terms must be followed precisely. For example, a delay in shipping or misspelling a company's name can lead to the bank refusing to make the payment.

There are two main types of standby letters of credit:

*   A financial SLOC 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 SLOC, 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.

> **Important**
>
> The recipient of a standby letter of credit is assured that it is doing business with an individual or company that is capable of paying the bill or finishing the project.

The procedure for obtaining a SLOC is similar to an [application for a loan](https://www.investopedia.com/articles/personal-finance/010516/how-apply-personal-loan.asp). The bank issues it only after appraising the creditworthiness of the applicant.

In the worst-case scenario, if a [company goes into bankruptcy](https://www.investopedia.com/articles/personal-finance/051115/7-bankrupt-companies-came-back.asp) or ceases operations, the bank issuing the SLOC will fulfill its client's obligations. The client pays a fee for each year that the letter is valid. Typically, the fee is 1% to 10% of the total obligation per year.

## Benefits of Using a Standby Letter of Credit in Trade

The SLOC 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 SLOC, 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 seller can present the SLOC to the buyer's bank for payment. Thus, the seller is guaranteed to be paid. Another advantage for the seller is that the SBLC reduces the risk of the production order being changed or canceled by the buyer.

An SBLC helps ensure that the buyer will receive the goods or service that's outlined in the document. For example, if a contract calls for the [construction](https://www.investopedia.com/articles/professionals/061215/10-ways-improve-cash-flow-construction.asp) of a building and the builder fails to deliver, the client presents the SLOC to the bank to be made whole. Another advantage when involved in global trade, a buyer has an increased certainty that the goods will be delivered from the seller.

Also, small businesses can have difficulty competing against bigger and better-known rivals. An SBLC can add credibility to its bid for a project and can often times help avoid an upfront payment to the seller.

## How Much Does a Standby Letter of Credit Cost?

Since a bank is taking a risk by offering a SBLC, there are fees to obtain one. Typically, banks will charge between 1% and 10% of the total guaranteed price for each year that the SBLC is active.

## Where Can I Apply for a Standby Letter of Credit?

Standby letters of credit are typically offered by commercial banks and lenders. The bank will assess the creditworthiness of the applicant much like a loan application.  

## When Would You Need an SLBC?

Standby letters of credit are often used in international trade deals where the terms may be different between parties, but that is not the only use. Anytime a buyer needs to guarantee payment for goods or services, a SBLC may be in order.

## The Bottom Line

A standby letter of credit (SLOC) is an essential tool in facilitating large business transactions, particularly in international trade. It provides assurance to both buyers and sellers that financial obligations will be met, even if a party defaults. While SLOCs offer significant advantages, such as reducing the risk of non-payment and enhancing credibility in contract bids, businesses must be aware of the associated costs and the thorough credit assessment process required by issuing banks.  

> **Article Sources**
>
> 1.  Trade Finance Global. "[Standby Letters of Credit (SBLC / SLOC)](https://www.tradefinanceglobal.com/letters-of-credit/standby-letter-of-credit-sblc/)."
>     
> 2.  Corporate Finance Institute. "[Standby Letter of Credit (SBLC)](https://corporatefinanceinstitute.com/resources/commercial-lending/standby-letter-of-credit-sblc/)."