Standby letter of credit vs bank guarantee: what's the difference for a small business?

A new overseas supplier offers you 60-day payment terms, then asks for “a standby letter of credit” to back them. Or a landlord’s lawyer sends a lease that mentions one when you were expecting a bank guarantee. The terms sound interchangeable. They aren’t quite, and the difference decides who can issue the paper, how fast, and what it locks up in your business.

What is a standby letter of credit?

A standby letter of credit is a bank’s written promise to pay a named beneficiary if you fail to meet an obligation, such as paying an invoice. The beneficiary asks for the money by presenting a demand that meets the instrument’s terms. The bank pays, then recovers the amount from you.

The word “standby” is the clue. In an ordinary documentary letter of credit, the credit is the way you pay: the supplier ships, presents documents and gets paid. With a standby, you’re expected to pay by other means, perhaps open account, and the credit sits in the background. As the ICC Academy puts it, standby beneficiaries treat the credit as security and hope it’s never drawn.

Also called: SBLC, standby LC, standby credit, and sometimes a “demand guarantee” when a bank issues it in guarantee form.

How is it different from a bank guarantee?

In everyday Australian business a bank guarantee is the instrument you meet most. CommBank describes it as replacing a deposit or bond you’d otherwise pay directly to a supplier, vendor or landlord, with rental bonds and contract performance guarantees as the common uses.

	Standby letter of credit	Bank guarantee
What it is	A bank’s undertaking, issued as a letter of credit	A bank’s undertaking, issued as a guarantee
Typical rulebook	ICC International Standby Practices (ISP98), or UCP 600 if the credit says so	Mainly the document’s own wording; some use ICC’s URDG for demand guarantees
Where you meet it	Overseas suppliers, foreign leases, international contracts	Commercial leases, head contractors, utilities, local suppliers
Draw process	A written demand plus any documents the credit lists	A written demand under the guarantee’s wording
Renewal	ISP98 expressly allows it	Usually a fixed term; extended by agreement
Who asks for it	Beneficiaries used to international trade	Beneficiaries used to local practice

That “rulebook” row is where the real difference sits. ISP98 is, in the ICC’s words, a set of rules intended for standby letters of credit including performance, financial and direct pay types. It covers practical points a plain guarantee leaves to chance, such as how long the bank has to examine a demand, how copies of documents are treated and whether the instrument can renew. Under the ICC Academy’s comparison, ISP98 gives the bank three to seven business days to examine a presentation, and Rule 3.09 expressly permits renewal.

For a small business the practical takeaway is simpler: the beneficiary chooses the form. If a supplier in Shenzhen or Auckland asks for a standby, a local-style guarantee may not be what their bank or lawyer expects. If an Australian landlord asks for a guarantee, an SBLC would probably be unusual. Ask what rules and wording they need before you approach your bank.

When would a supplier or landlord ask for one?

Three situations come up most:

1. Open account terms from an overseas supplier. You want 30, 60 or 90 days to pay, they want comfort. A standby lets them extend terms while knowing a bank will pay if you don’t. It’s a middle road between prepaying and a full documentary credit.
2. A larger first order with a new supplier. Suppliers sometimes ask for a standby for the first few shipments, then relax once you’ve built a payment record.
3. A lease or contract with an international party. A foreign-owned landlord or a global franchisor may want a standby rather than a local guarantee.

What does a bank need before it issues one?

Exactly what it needs depends on the bank and your financials. In general, expect the following.

• Security. For a cash-secured guarantee, CommBank says the security is usually cash in an eligible deposit account, with property possible by arrangement. Standbys follow the same logic: the bank is lending its credit standing, so it wants something behind it. NAB lists an outward standby letter of credit among its trade products, under which it pays the beneficiary if the terms of your trade contract aren’t fulfilled.
• Fees. Typically a one-off establishment fee plus an ongoing fee for the life of the instrument, charged in advance. Changes after issue can cost extra.
• A clean recent history. CommBank says approval is more likely if you haven’t been overdrawn or in arrears in the past three months and haven’t been bankrupt in the past five years.
• A clear beneficiary and wording. Banks need the beneficiary’s exact legal name and, for a guarantee, a valid ABN or ACN. Expect a few rounds of wording changes.

Smaller businesses often find the “who will issue it” step harder than the “what’s it called” step. Big-bank trade teams focus on larger corporates, so a business with $1m to $10m turnover may need to line up the security first and let the facility follow.

What does it tie up in your business?

A standby never goes through your bank account, so it’s easy to forget it’s a liability. It isn’t free money. Three things tie up:

• Cash. The bank may hold a deposit equal to the amount. That cash can’t pay wages or stock while the instrument is live.
• Property. It might be secured against a home or commercial property, limiting other borrowing against it.
• Your limit. If issued under an existing facility, it reduces what you can draw. A standby can leave you with less headroom in the weeks you need it most.

Here’s an illustrative example only. A Melbourne homewares importer wants 60-day terms from a new overseas supplier. The supplier asks for a $80k standby for six months. The owner’s bank will issue it against a cash deposit of the same amount. That’s $80k not available for freight, duty or the next order, even if the standby is never drawn. In the same month the importer has a Christmas stock order to fund. The standby didn’t cost much to establish, but it made the cash cycle tighter.

What happens if the supplier draws on it?

The bank pays the beneficiary against a compliant demand, without judging whether the underlying dispute is justified. You then owe the bank. If you’ve lodged cash, it simply uses that; if you used a limit, your limit shrinks and the amount becomes a debt to be repaid.

So don’t treat a standby as a bluff the supplier won’t call. If you’re going to be late with a payment, speak to the supplier early. A short written extension is almost always cheaper than a call.

Can a small business get one, and what if you can’t afford the security?

Usually yes, if the bank is comfortable with your trading history and you can lodge security. It’s the funding of that security that most small importers and contractors struggle with.

Options to look at:

• Ask for a smaller amount or shorter term. A standby for the first two shipments rather than the whole year cuts the tied-up cash.
• Ask whether a guarantee will do. If the beneficiary’s lawyer is flexible, a local bank guarantee may be quicker to arrange.
• Use a facility instead of cash. A business line of credit can leave your deposits free, but check how the bank counts the instrument against the limit.
• Fund the security. A loan against property or the business can free up the cash to lodge. Our trade finance and import finance pages show how those shelves fit together.
• If you’re an exporter, look at government options. Export Finance Australia, the federal export credit agency, lists bonds and guarantees among its solutions, though eligibility and size limits apply.
• Take a different route for the supplier. Sometimes a trade finance loan paying the supplier directly removes the need for the standby at all.

If you’re not sure which of these suits your order, tell us what the supplier or landlord has asked for and we’ll point you at the right shelf.

For the contracting version of the same question, see our guide to insurance bonds vs bank guarantees.

Four checks before you agree to either

1. Get the beneficiary’s required wording in writing. Don’t let your bank draft from scratch and hope.
2. Set an expiry. CommBank recommends agreeing an expiry date because claims could otherwise arrive after your obligation has ended. Diarise it.
3. Confirm how it counts against your limits. Ask your banker in writing.
4. Plan the return. At the end, get the original back to the issuer. Until then the limit may stay reduced.

Need the security funded? Let’s look at it together

A standby letter of credit or bank guarantee request tends to arrive with a deadline and a lot of jargon. The paperwork is the easy part; working out where the cash comes from is where we can help. If you’d like to know what you could borrow to cover the security, or whether a different structure avoids it altogether, we’ll look at your order, your supplier terms and your business and talk it through.

It takes about 60 seconds to enquire, and there’s no credit check at this stage, so asking won’t touch your credit file. We don’t send your details to a pile of lenders, so you won’t get a wave of unexpected calls. A real person reads your situation and phones you to go through the options.

Please fill in the form accurately, including the amount, the term and who’s asking for the instrument, so we can match the right option first time.

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