Stand-by Letter of Credit to secure commercial and financial transactions in Africa

What is the stand-by letter of credit?
Why use the Stand-by letter of credit?
How does the Stand-by Letter of Credit work?
The Stand-by letter of credit in transactions in Africa
What to remember about the stand-by letter of credit

A stand-by letter of credit is a financial instrument that serves as security for a commercial or financial transaction. It is issued by a bank on behalf of a customer and is used to guarantee payment of a specific amount in the event of breach of a contract or agreement.

The stand-by letter of credit is similar to a bank guarantee. It is used to protect both parties involved in a transaction. The beneficiary of the stand-by letter of credit is protected against the risk of non-payment, while the issuer is protected against the risk of financial loss in the event of the beneficiary’s non-compliance with the contract.

In more detail, the Stand-by letter of credit is used for various reasons, including:

1. Guarantee payment: The Stand-by letter of credit is used to guarantee payment of a specific amount in the event of a breach of a contract or agreement. This allows the beneficiary of the Stand-by Letter of Credit to have additional assurance that payment will be made.
2. Reduce risks: The Stand-by letter of credit reduces the risks for both parties involved in the transaction. The beneficiary is protected against the risk of non-payment, while the issuer is protected against the risk of financial loss in the event of non-compliance by the beneficiary.
3. Facilitate international transactions: In international transactions, the Stand-by Letter of Credit can be used to overcome the difficulties related to the differences in laws and regulations in different countries. It can also help overcome barriers related to distance and differences in languages and cultures.
4. Reinforce credibility: The Stand-by letter of credit reinforces the credibility of the issuer and the beneficiary. It shows that the issuer is willing to put collateral in place to secure payment, which can build trust in the transaction.

The Stand-by letter of credit works as follows:

1. The beneficiary (the seller or the supplier) and the buyer conclude a contract which specifies the terms of the transaction, including the terms of payment.
2. The buyer asks his bank to issue a Stand-by letter of credit in favor of the beneficiary. This letter of credit is a guarantee that the buyer will pay the amount agreed in the contract, even in the event of non-fulfilment of his obligations.
3. The buyer’s bank issues the Stand-by letter of credit, which is forwarded to the beneficiary’s bank.
4. The beneficiary can use the Stand-by letter of credit to obtain payment, by providing documentary evidence that the buyer has not fulfilled his obligations under the contract. This documentary proof must comply with the terms of the Stand-by letter of credit.
5. The beneficiary’s bank examines the documentary evidence and, if it complies with the terms of the Stand-by letter of credit, makes the payment.
6. Beneficiary’s bank then submits the documentary evidence and payment request to the buyer’s bank for reimbursement.
7. The buyer’s bank examines the documentary evidence and, if it complies with the terms of the Stand-by letter of credit, reimburses the beneficiary’s bank.

The Stand-by letter of credit is widely used in Africa to secure commercial and financial transactions. It is particularly useful for international transactions involving parties located in different countries, as it helps reduce risk for both parties involved and makes the transactions easier.

In Africa, the Stand-by Letter of Credit is used in various sectors, such as agribusiness, energy, mining, manufacturing, transport and logistics. It is often used to guarantee payment for imported goods, but can also be used to guarantee payment for services or other commercial transactions.

However, the use of Standby Letter of Credit in Africa may be hampered by challenges such as lack of awareness of this financial tool by some businesses, high costs associated with its use, as well as difficulties related to regulatory compliance.

Despite these challenges, the Standby Letter of Credit remains an important tool for commercial transactions in Africa. It can help build trust between parties involved in a transaction, reduce risks and facilitate international transactions.

In summary, the stand-by letter of credit is an important financial tool to secure payment in commercial or financial transactions, especially in international transactions where risks may be higher.

The Stand-by letter of credit functions as a financial guarantee issued by the buyer’s bank on behalf of the beneficiary. The Beneficiary may use the Stand-by Letter of Credit to obtain payment by providing documentary evidence in accordance with the terms of the Stand-by Letter of Credit. If the proof is accepted, the beneficiary’s bank makes the payment and the buyer’s bank reimburses the beneficiary’s bank.