If you have spent any time dealing with banks, trade contracts, or international business, you have almost certainly come across both a Standby Letter of Credit and a Letter of Credit. They share a name, they are both issued by banks, and they both provide a form of financial guarantee. But they operate in completely different ways, serve entirely different purposes, and using the wrong one in a transaction can expose your business to risks you did not sign up for. This guide explains both instruments clearly, how they differ, when to use each, and what Businesses Across the US in trade, construction, services, and SMB operations need to know before committing to either.
What Is a Letter of Credit?
A Letter of Credit (LC) is a payment instrument issued by a bank on behalf of a buyer. It guarantees the seller will be paid, provided they meet specific documentary conditions outlined in the LC terms.
The key word is documentary. An LC pays when the seller presents the right documents - typically a bill of lading, commercial invoice, packing list, and any other documents specified in the agreement. Once those documents are verified as compliant, the bank releases payment. The buyer's ability or willingness to pay at that point is irrelevant. The bank has already committed.
Letters of Credit are governed by the UCP 600, the Uniform Customs and Practice for Documentary Credits published by the International Chamber of Commerce (ICC). UCP 600 is the global standard that banks follow when issuing and processing commercial LCs. Letters of Credit are the primary payment tool in international trade. When a buyer from the US buys goods from a manufacturer in Vietnam or a food supplier in Brazil, the seller often requires an LC because it eliminates payment risk. Once the goods ship and the documents are in order, payment is guaranteed regardless of anything that happens to the buyer.
Primary use cases for a Letter of Credit:
International trade transactions between buyers and sellers in different countries New trading relationships where trust has not been established High-value shipments where the seller needs payment certainty before manufacturing or shipping Any transaction where documentary proof of shipment and compliance is the natural trigger for payment
What Is a Standby Letter of Credit?
A Standby Letter of Credit (SBLC) is a bank-issued guarantee of last resort. Unlike a commercial LC which is designed to be drawn upon as the normal payment mechanism, an SBLC is never meant to be used in the normal course of business. It activates only if something goes wrong - specifically, if the applicant fails to fulfil their payment or performance obligation. Think of an SBLC as a financial safety net held in the background. The seller or beneficiary hopes they will never need to draw on it. But if the buyer defaults, misses a payment, or fails to perform on a contract, the beneficiary can present proof of default to the bank and the SBLC pays out.
SBLCs are often governed by the ISP98 (International Standby Practices), though UCP 600 is sometimes applied. ISP98, published by the ICC in 1998, was specifically designed for standby instruments where the drawing trigger is non-performance rather than document compliance. Primary use cases for a Standby Letter of Credit: Construction contracts where the contractor needs to guarantee project completion Commercial real estate leases where a landlord requires financial assurance from a tenant Service contracts where one party needs a performance guarantee from the other Loan agreements where a lender requires a bank guarantee as credit support Repeated business relationships where an ongoing guarantee is required rather than a single transaction payment
What are the Key Differences between Standby Letter of Credit & Letter of Credit
| Factor | Letter of Credit (LC) | Standby Letter of Credit (SBLC) |
|---|---|---|
| Primary Purpose | Payment instrument | Guarantee of last resort |
| When It Activates | When compliant documents are presented | Only when the applicant defaults or fails to perform |
| Governing Rules | UCP 600 (ICC) | ISP98 or UCP 600 |
| Intended to Be Drawn | Yes | No |
| Number of Transactions | Typically one transaction per LC | Can cover multiple transactions or an ongoing relationship |
| Industries | International trade, import/export | Construction, real estate, services, banking, contracts |
| Who Benefits | The seller (payment assurance) | The beneficiary (performance/payment guarantee) |
| Trigger for Payment | Compliant shipping and trade documents | Proof of default, non-payment, or non-performance |
| Cost | 0.75%–1.5% of transaction value | 1%–3% annually of the guaranteed amount |
| Best For | Importers, exporters, international buyers | Contractors, tenants, service providers, domestic businesses |
A Letter of Credit moves money as part of the deal. A Standby Letter of Credit sits in the background in case the deal falls apart.
A commercial LC is the payment mechanism. The seller ships goods, presents documents, and the bank pays. The LC is used every single time because it is the agreed method of payment. It is not a safety net. It is the transaction itself.
An SBLC is never supposed to be triggered. If an SBLC is drawn upon, it means the applicant could not or did not meet their obligation. The entire commercial relationship went sideways. The SBLC is compensation for that failure.
This distinction matters enormously when choosing which instrument your business needs. A construction company required to post a performance bond on a government contract needs an SBLC, not a commercial LC. An importer buying goods from a new overseas supplier needs a commercial LC, not an SBLC.
Who Uses Each Instrument in US Business?
Letters of Credit are primarily used by:
Importers and exporters managing cross-border transactions. US businesses buying goods from overseas manufacturers frequently use commercial LCs to give suppliers payment certainty. US exporters selling to international buyers may also be asked to provide or work within an LC structure. The commercial LC market in the US is concentrated among businesses engaged in international trade, manufacturing imports, and commodity purchasing.
Standby Letters of Credit are used across a much broader range of US businesses: Contractors and construction companies - SBLCs are standard in US construction contracts, particularly for public projects, infrastructure, and commercial real estate. A general contractor may be required to post an SBLC guaranteeing project completion or performance. Commercial real estate tenants - Landlords regularly require SBLCs from business tenants, particularly at lease commencement or in lieu of a large cash deposit. The SBLC guarantees rent payments if the tenant defaults.
Service businesses - Companies providing long-term services or entering into supply agreements may be asked to post an SBLC as a performance guarantee.
SMBs and growing businesses - Any business entering a significant contract with a larger counterparty may face a request for an SBLC as a condition of the deal. This is more common than many SMB owners expect.
Cost Comparison
Letter of Credit costs: Banks typically charge 0.75% to 1.5% of the LC value as an issuance fee. Additional charges may include amendment fees, discrepancy fees if documents are not fully compliant on first presentation, and advising bank fees. For a $500,000 import shipment, LC fees might run $4,000 to $7,500.
Standby Letter of Credit costs: SBLCs are typically priced as an annual percentage of the guaranteed amount, generally between 1% and 3% per year. A $200,000 SBLC guaranteeing a commercial lease might cost $2,000 to $6,000 annually. Unlike an LC, the SBLC fee is paid whether or not the instrument is ever drawn upon.
Both instruments require the applicant to have sufficient credit with the issuing bank. In some cases, banks require cash collateral equal to the LC or SBLC amount, which ties up working capital for the duration of the instrument.
When to Use a Letter of Credit vs a Standby Letter of Credit
Choose a Letter of Credit when:
- You are buying goods from an overseas supplier for the first time
- Your supplier demands payment certainty before producing or shipping goods
- The transaction involves physical goods with verifiable shipping documentation
- You are exporting goods and your buyer's bank is issuing the LC as the payment mechanism
Choose a Standby Letter of Credit when:
- You are entering a construction contract and the owner requires a performance guarantee
- Your new landlord requires financial assurance at the start of a commercial lease
- You are a service provider and your client requires a guarantee against non-performance
- A bank or lender requires credit support before extending a loan or facility
- You need to guarantee ongoing payment obligations over a period of time rather than a single transaction
Frequently Asked Questions
What is the main difference between a Standby Letter of Credit and a Letter of Credit? A Letter of Credit is a payment instrument used in trade transactions. It pays when the seller presents compliant documents. A Standby Letter of Credit is a guarantee of last resort that only activates if the applicant defaults or fails to perform on a contract. One is designed to be drawn. The other is designed to sit unused.
Is a Standby Letter of Credit a type of Letter of Credit? Yes, technically. An SBLC is a subcategory of letters of credit. But in practice they function completely differently. A commercial LC is a payment tool. An SBLC is a performance or payment guarantee. They serve different contractual purposes and are used in different industries and situations.
Which is more expensive, an LC or an SBLC? It depends on the transaction size and duration. A commercial LC charges 0.75% to 1.5% of the transaction value per issuance. An SBLC charges 1% to 3% annually of the guaranteed amount, whether drawn or not. For a single large trade shipment, the LC fee is a one-time cost. For an ongoing contract guarantee, the SBLC fee recurs annually.
Can a small business use a Standby Letter of Credit? Yes. Any business that has a banking relationship with a sufficient credit line can request an SBLC. Landlords, construction owners, and large contract counterparties regularly require SBLCs from SMBs as a condition of the deal. If your bank requires cash collateral to back the SBLC, that can create a working capital constraint worth planning for in advance.
Does an SBLC affect working capital? It can. If your bank requires you to hold cash collateral equal to the SBLC amount, that cash is effectively frozen for the duration of the instrument. For SMBs and growing businesses, this can create meaningful working capital pressure. Planning your financing around this requirement before committing to an SBLC is important.
What happens if an SBLC is never drawn? The SBLC expires at the end of its term and the applicant has no further obligation. The fee paid for the issuance is non-refundable, but no payment goes to the beneficiary. In most cases, this is exactly the intended outcome.
How Drip Capital Supports Businesses Managing Trade Finance Instruments?
Whether you are using a commercial Letter of Credit for an import transaction or managing the working capital impact of an SBLC posted as a performance guarantee, the underlying challenge is the same: cash is committed or tied up before revenue comes in.
Drip Capital provides Vendor Financing, Receivables Financing, and a Line of Credit for Businesses Across the US in trade, manufacturing, distribution, and wholesale. With credit lines up to $3 million, funding in 24 to 48 hours post approval, no personal guarantee (in most cases), and no UCC blanket lien, Drip Capital is built for the cash flow realities of businesses operating in complex trade and contract environments.
Over $9 billion in trade transactions facilitated. More than 11,000 businesses served globally. Apply now or call +1 (650) 437-0150 to speak with a trade finance specialist.
