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Introduction: 

In the cutthroat world of global trading, trust is the currency that matters most. But when it involves an associated party that could be on the other side of the ocean or operates within a different legal framework, merely "trusting" that funds will be received or the service delivered could be highly inadequate. This is where Standby Letters of Credit (SBLCs) or Bank Guarantees (BGs) come into consideration. 

Though both are types of "safety nets" provided by banks to reduce risks associated with funding, they cannot be used interchangeably. 

Failure to use the right one may result in increased expenses, legal troubles, or even a scrapped deal.

Let's find out which is right for your trade deal:

1. Defining the Instruments :

Standby Letter of Credit (SBLC) :

SBLC stands for a Secondary Payment Method. Unlike a Standard "Commercial Letter of Credit," SBLC is not intended to be a primary payment option; instead, it is meant to operate as a "background" device. SBLC is a "just in case" tool. 

In case the buyer defaults on payment to the seller, the bank becomes responsible for making up the payment under certain document requirements, for example, a default statement as well as a copy of the unpaid invoice. 

Bank Guarantee (BG) :

The Bank Guarantee is a more direct payment commitment by a bank to pay a certain amount in case a party does not fulfill a contract obligation. They are often used as "performance" instruments. A company, for instance, that does not complete a construction job on time can have their bank guarantee "called" by their client. 

2. Key Differences: SBLC / Bank Guarantee :

Feature |Standby Letter of Credit (SBLC) | Bank Guarantee (BG) | 

• Primary Usage : International Trade & Cross-border deals | Domestic Projects & Infrastructure | 

• Trigger : Documentary proof of default | Failure to perform/pay | 

• Governing Rules: International (UCP 600 or ISP 98) | Local/National Law of the issuing country | 

• Complexity : High (Strict document compliance) | Moderate (Based on contractual breach) | 

• Parties Involved : Typically 4+ (Buyer, Seller, Issuing Bank, Advising Bank) | Typically 3 (Applicant, Beneficiary, Bank) |

3. When to Use a Standby Letter of Credit (SBLC) :

When your trade agreement is global, the SBLC will always be the preferred option for you. 

Standardization: SBLCs are regulated by the International Chamber of Commerce (ICC) Rules, which are either the UCP 600 or the ISP 98. This implies that a Singapore bank and a New York bank can deal with the document the same way despite the differences in local laws. 

• Payment Security: It works well for exporters who need assurance that they will receive their funds in case of the failure of the business of the purchasing company. 

• Credit Enhancement: Companies can utilize SBLCs for credit enhancement purposes, enabling them to negotiate improved credit terms from their suppliers, as their credit standing has been improved by the 'gold-plated guarantee' provided by the bank. 

4. When to Use an International Bank Guarantee: 

Bank Guarantees are the workhorses of the Construction Industry & Service Industry. They exist in several specialized forms known as "Performance Guarantees": 

• Tender/Bid Bonds: This type of bond is designed to ensure that a firm does not withdraw a bid once it is awarded a tender. 

• Performance Guarantee: It assures the quality and on-time delivery of a particular project. 

• Advance Payment Guarantees: In case a contractor charges you 20% in advance to begin working on your project and leaves without completion , this ensures you get your advance back. 

Although BGs are widely applicable globally, they are sometimes liable to the laws of the country in which the bank resides. This may lead to "jurisdiction risk" if both parties are located in countries with legal systems that differ considerably. 

5. The 'Secondary vs. Primary' Liability Myth: Although: 

In most cases, it becomes confusing as to whose money it is. 

• Within an SBLC, the bank has a direct liability to the beneficiary. When the documents are in order, the bank has to make payments, irrespective of the discrepancies between the buyer and the seller. 

• In a Bank Guarantee, there may be a secondary liability of the bank. The beneficiary must show the applicant defaulted on the agreement before making any claims. But the newer "On-Demand Guarantees" have filled the gap and now function more like an SBLC. 

6. Decision Making: a checklist :

In order to determine whether it's the correct investment option for your transaction, you need to consider these three questions: 

• " Where is the counterparty? 

If the counterparty is abroad, the SBLC's international standardization (ISP 98) provides greater security." 

• What are you guaranteeing? 

If it is a "pay for these goods" type, you would want to use an SBLC. If it is a "build a bridge to these specifications" type, then a Performance Bank Guarantee would be preferred. 

• What is the cost? 

SBLCs can turn out to be more expensive because of the work involved in examining documents, and the "local" risks might be higher even though the fees of BGs are relatively low. 

Conclusion :

Ultimately, the decision to use a Standby Letter of Credit versus a Bank Guarantee depends on the nature of the risk. When it comes to securing payments in international business, the SBLC is supreme. When it comes to ensuring performance or services, the bank guarantee is the way to go.