You might be asking what the benefits are for leasing a bank instrument or considering other options than risking your own collateral to secure a line of credit?
The Benefits of Leasing an SBLC:
- It’s very good for trade finance
- It’s a good to give the Seller comfort should the Buyer not pay for goods received
- It’s a good way for a Purchaser to buy goods to sell on to a Buyer waiting in the wings and use proceeds from sale to pay for the goods purchased from the Seller.
How Does Leasing An SBLC Work?
Let’s say you are a factory turning soy beans into soya milk. You have an order from the local supermarket worth $150M, you want to buy $100M worth of soy beans from a Supplier, in your bank account you have $250M.
You may be concerned that with other outgoing costs, this order could leave you very little money for other expenses. Instead of taking out the full $100M from your bank account to put up as collateral to receive a loan to purchase the soy beans, you might choose another (safer) option.
You could raise a bank instrument to show your Supplier that you have the financial means ready to purchase the soy beans from them. This bank instrument will come from a Third Party Provider who will let you lease their collateral at say 10% of the cost so now you are only spending $10M instead of risking $100M. By leasing a bank instrument means you are a temporary lessee for one year and one day.
Normally invoices are issued on a 45, 60 or 90 day invoicing cycle. So theoretically you could purchase the soy beans from the Supplier by taking out a bank instrument. This would then be assigned to the Supplier as backup should you default on settling the invoice – this is very common in trade finance.
In trade finance the Supplier will want assurances by way of a bank instrument to demonstrate that should an invoice not be settled, they can call on the instrument and cash it in to collect their payment. If this is timed correctly, the Purchaser of the soy bean can receive the goods, convert it into soya milk to sell onto the supermarket who in turn pays the $150M which has been pre-agreed and the Supplier can in turn settle the $100M (the cost of the soy beans from the Supplier) within the stipulated timelines and only risk very little of their own money.
Example Of Leasing An SBLC:
Supplier sells the soy beans for $100M
Purchaser leases a bank instrument at 10% of face value of the instrument. Therefore the cost to lease in this case is $100M x 10% = $10M
Purchaser puts up the instrument as a ‘promise to pay’ should the purchaser default on payment of the $100M invoice and supplier proceeds to supply the soy beans
Purchaser takes shipment of goods and processes the soy beans into soy milk
Purchaser then sells the soy milk immediately to the supermarket for $150M
The supermarket settles the $150M invoice immediately
Purchaser then takes the $150M and settles the $100M right away and makes a $40M profit ($150M less $100M less $10M for the cost of leasing the instrument) without having to provide the full $100M upfront. The whole transaction essentially cost them $10M and they managed to make $40M in the process
Buying An SBLC
If you are looking to buy an SBLC there are some advantages and disadvantages to be aware of. The main advantage of Buying a StandBy Letter Of Credit is that you become the official owner of the instrument and in turn you would be able to lease the bank instrument out to a Third Party. Considerations need to be made as the price of the bank instrument won’t be cheap as the cost to purchase would start at around 30% plus of face value. So if you want to buy a StandBy Letter of Credit for $100M, the price to purchase would start around $30M therefore you would need to weigh up the benefits of purchasing v’s leasing a bank instrument.