A letter of credit and a standby letter of credit are similar services offered by banks to aid financial transactions between buyers and sellers. The bank issuing either of these letters guarantees payment to the seller if certain requirements are met.
Differences
The difference between these two services is the role of the bank. In a letter of credit, the bank essentially acts as the buyer, providing payment once the seller meets the deal requirements. In a standby letter of credit, however, the bank acts as an insurer. The bank pays the seller in the event the buyer fails to meet the deal requirements.
Purpose of a Letter of Credit
A letter of credit is typically used to ease the transaction process for both the buyer and seller. It allows for prompt payment and the ability to substitute the credit of the buyer for that of the issuing bank, and lessens the threat of litigation.
Purpose of a Standby Letter of Credit
A standby letter of credit is primarily used to lessen the risk that the buyer will fail to pay.
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