Standby letter of credit
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A bank's backup promise: it pays the other side if its customer fails to pay or perform as the contract says.
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01 · In plain words
A bank promises to pay you if the other side does not pay or perform
A , or standby LC, is a bank's backup promise. It is a type of . The seller can claim on it if one side fails to do what the contract says, for example when an importer does not pay its invoices on time (US International Trade Administration).
In a normal sale, the buyer pays the seller directly. The bank is in the background. If the buyer pays as agreed, nobody draws on the standby LC and it ends (ICC Academy).
The bank's promise is irrevocable. That means the bank cannot take it back on its own (FDIC). To be paid, the beneficiary sends the bank a demand, a written request for payment, with the documents the standby LC lists (UN Convention). The bank checks those documents only. It does not look into any dispute between the buyer and the seller (12 CFR 7.1016).
Who is involved
- The asks its bank for the standby LC. In a sale on credit terms, this is the importer. The applicant signs a , a promise to repay the bank for anything the bank pays out.
- The can demand payment if the applicant defaults. In a sale on credit terms, this is the exporter.
- The applicant's bank, the , makes the promise to pay.
- Sometimes a adds its own promise to pay. See Confirmed letter of credit.
02 · How it works
Eight steps take a standby LC from the sale agreement to repayment of the bank
Figure 1 · Interactive
A standby letter of credit, step by step
Read down the steps. Steps 5 to 8 happen only if the buyer defaults.
Sources: US ITA, Trade Finance Guide, 2022; FDIC, RMS Manual section 3.8; UN Convention on Independent Guarantees and Stand-by Letters of Credit, 1995; 12 CFR 7.1016; ICC Academy.
03 · What it means for you
The exporter gets a bank to fall back on, and the importer gets credit terms but must repay the bank for any payout
Figure 2 · Interactive
What a standby LC means for each side
Choose your side of the trade.
04 · Worked example
On a $1 million standby LC, an illustrative fee comes to $10,000, and a $250,000 drawing is repaid by the buyer
This example uses round, made-up numbers. A $1,000,000 standby LC is open for 360 days, with a fee of 1.00% a year. A year counts as 360 days here. If the buyer pays every invoice, there is no demand and the bank pays out $0. The fee is the only cost. If the buyer fails to pay $250,000 of invoices, the seller demands that amount.
Figure 3 · Illustrative
Fee and drawn case on a $1,000,000 standby LC open for 360 days
Illustrative inputs. The buyer's repayment is highlighted.
Made-up rates, worked out by our checking script. Your bank's fees will differ by bank, country and deal.
05 · When to use it
A standby LC suits sales on credit terms and contracts where one side must prove it will perform
Good fit when
- You sell on open account and want a bank to fall back on if the buyer does not pay (US ITA).
- You must back a bid, your performance of a contract, or the return of an advance payment. A standby LC can serve as a bid bond, a or an (US ITA).
- You need to assure performance under a construction contract or a payment owed to a major supplier (FDIC).
Another tool may suit better when
- You want the bank to be the way the goods are paid for. Look at a sight letter of credit.
- The other side asks for a bank guarantee. ICC Academy calls standby LCs very similar to a , with the main differences in terminology and practice. See Demand guarantee (bank guarantee).
- As the buyer, you cannot accept your bank paying a demand you dispute. The bank pays on matching documents, whatever the dispute (12 CFR 7.1016).
06 · Rules and a real case
A standby LC follows the rules it names, and a court has upheld a beneficiary's demand
A standby LC can say it follows , the International Standby Practices. ISP98 is ICC Publication No. 590. It took effect on January 1, 1999, and the ICC and UNCITRAL endorse it (IIBLP). It had not been revised as of January 2024 (ICC Documentary Credit World).
A standby LC can also follow . Those rules were written for letters of credit that pay for goods, so considerable care is needed when using them for a standby LC (IIBLP). The 1995 UN Convention on Independent Guarantees and Stand-by Letters of Credit also covers standby LCs (UNCITRAL). In the US, banking rules name ISP98, UCP 600 and the UN Convention among the rules of practice a US national bank's standby LC can follow (12 CFR 7.1016).
A real case. In National Infrastructure Development Co Ltd v Banco Santander SA, decided on January 26, 2017, standby LCs of about USD 38 million backed a contractor's work on a highway project in Trinidad and Tobago. The project owner ended the contract and demanded payment. The Court of Appeal of England and Wales upheld summary judgment for the project owner. It said it cannot be fraudulent to make a demand one is entitled to make. Under the , a bank can refuse to pay for fraud only with very strong proof that the beneficiary acted dishonestly (Court of Appeal judgment).
Summary
A standby LC is a backup promise: it can be drawn when one side fails to pay or perform
If the buyer pays as agreed, the standby LC is never used and the cost is the fee. If the buyer defaults, the seller makes a demand that matches the standby LC, the bank pays, and the buyer repays the bank. Both sides should agree the documents for a demand before the bank issues it.
Related guides: Standby letters of credit vs bank guarantees; Letters of credit; The payment terms spectrum. Related cards: Demand guarantee (bank guarantee); Open account; Letter of credit (sight). Every term is in the Trade Finance Glossary.
Sources
- US International Trade Administration, Trade Finance Guide: A Quick Reference for US Exporters, Chapters 4 and 6, 2022. Supports: definition, use with open account terms, bid, performance and advance payment uses
- Federal Deposit Insurance Corporation, RMS Manual of Examination Policies, Section 3.8 Off-Balance Sheet Activities, June 2019. Supports: irrevocable commitment, reimbursement agreement, periodic fee, construction and supplier uses
- US Office of the Comptroller of the Currency, via eCFR, 12 CFR 7.1016, Independent undertakings to pay against documents, up to date as of September 17, 2026. Supports: payment against documents only, confirmation, recognized rules of practice
- UNCITRAL (United Nations), United Nations Convention on Independent Guarantees and Stand-by Letters of Credit, December 11, 1995. Supports: demand in conformity, irrevocable on issuance, when payment may be held back
- Institute of International Banking Law and Practice, ISP98 page, undated. Supports: ISP98 publication, effective date, endorsement, care with UCP for standbys
- ICC Academy, Types of documentary credit: a comprehensive guide, October 21, 2024. Supports: default-only backup, similarity to demand guarantees
- ICC Digital Library (Documentary Credit World), International Standby Practices ISP98: 25 Years, January 2024. Supports: ISP98 not revised since 1998
- Court of Appeal of England and Wales, National Infrastructure Development Co Ltd v Banco Santander SA [2017] EWCA Civ 27, January 26, 2017. Supports: the real case
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