Question

. Define standby credit letters comment on their growth in recent years, identify the principal parties to a standby credit agreement, point out the risks that accompany a standby credit letter for (a) the issuer and (b) the beneficiary and point out how can a lending institution mitigate the risks inherent in issuing standby credit letters

Answer 1

Answer

Definition

A stand by letter of credit actually means a guarantee of payment given by the bank on behalf of their customer.It acts like a last resort for the customer in which bank fulfills the payment obligations if the customer is not able to meet it.

Growth of Stand by Credit in recent years

The Stand by letter of credit seems to be growing in the recent years especially it provides financial assistance to the low- income countries with short term balance of payment needs. This is beneficial for them during the time of crisis or depression.It provides the financial support more flexible and better tailored to the diverse needs of teh low- income countries.They are getting a facility here to meet their short term balance of payment needs.This will help ultimately them for their economic development . These assistance will carry a 0 interest , most probably it happens from 2021 onwards.

Principal parties in a Stand by Credit Agreement

Main parties in a Stand by credit facility are as follows

1.Issuing Bank or Issuer

2. Applicant - Customer

3.Advising Bank - Normally the advising bank represents the beneficiary

4.Beneficiary - The party in whose favor the credit is issued.

5. Confirming Bank - The bank asked to confirm the credit by the issuing bank

6. Nominated Bank - The bank is nominated by the issuing bank at which the beneficiary may present the documents required by the credit and obtain the payment.

Risk for the Issuer

Volatile Business Environment, Constantly changing banking policy in the banking sector, political upheavals,transactions involved with force majeure risks. Also the Issuer / bank should check the legality of the parties before issuing.Banks also cannot claim money if the beneficiary is insolvent.

How to mitigate the risk of Issuer

Banks / Issuer should study regarding the applicants, nature of contracts, business activities of the parties in order to avoid situation of risk. The information regarding the transactions should be always be clear.Misunderstandings should be avoided.

Risk for the beneficiary

If the beneficiary violates the conditions of the contract, also the beneficiary doesn't able to meet the payment within the validity period.If false Documents submitted by the beneficiary.

How to mitigate the risk of beneficary by the lending institution

Proper communication between the beneficiary as well as the issuer is required here .The operational staff of the bank should study regarding the applicant, nature and terms of conditions of contract before issuing.

Also the bank should forecast regarding the economic conditions of the economy and business environment before entering in to a contract, also the issuer / bank should study properly regarding the credit worthiness of the customer before issuing.