When a bank issues a letter of credit to a customer, the bank is actually lending its credit support to the bank customer to enable a business trade or transaction by the customer. The two primary types of letters of credit are commercial and standby. While the commercial type serves as a payment device for the transaction, the standby letter of credit is a source of secondary payment. Fortunately for the bank customer, there are certain loopholes written into, or allowed by, the general regulations for these letters. These loopholes can be of assistance to bank account holders in certain instances in which there are legitimate unforeseen changes in the bank customers' personal or business circumstances that keep them from fulfilling specific stipulations of their letters of credit.
Although commercial banks, in general, are very skillful in executing letters of credit with precision and accuracy, these letters may have occasional errors that provide convenient loopholes for bank customers. In addition, often one or more of the supporting documents for these letters contain informational defects or discrepancies, such as the following:
Whenever errors or discrepancies are identified in letters of credit, payment transactions for the goods concerned cannot be made unless the parties involved are in agreement that these discrepancies should be waived. If an agreement to waive such inconsistencies cannot be reached, this halt in a trade transaction unintentionally gives additional time to both buyer and seller, or importer and exporter, of merchandise in finalizing a sale. In some cases, such a delay can even carry a portion of a company's income over into the next income tax quarter or year. It may also give slow sales months an extra boost in profits or delay payments due until the bank issuing the letter of credit makes necessary or acceptable additions or corrections to the letter or its supporting documentation.
When a bank issues a standby letter of credit on behalf of an account holder, the bank is giving assurance of this bank customer's capability to fulfill financial terms of a business contract. The receiving party of this letter is the beneficiary. Since a standby letter of credit is defined as a secondary payment device, neither party involved in the business transaction it serves has expectations of any funds being drawn against this letter.
Virtually the same loophole possibilities exist for both a commercial letter of credit and a standby letter of credit, as fully explained by the Credit Research Foundation. By issuing standby letters of credit, banks do more than simply lending their support to their customers' monetary obligations. These letters also may be employed to guarantee the refunding of advance payments, to back up performance and bid commitments or to guarantee the finalization of a sales contract. All standby letters of credit and commercial letters of credit must have expiration dates. It is true that the specific rules and regulations pertaining to all letters of credit do provide opportunities for possible loopholes relative to their validity and execution. However, all such loopholes should be used by bank customers only when they apply legitimately to a given business transaction.