The Issuance of a Bank Credit Instrument
(Standby Letters of Credit)

A bank receives an indication from a client that the client is willing to “buy from the bank a one year obligation, zero coupon, and effectively unsecured by any of the physical assets of the bank. The credit instrument is based solely on the “full faith and credit worthiness of the bank”.

Obviously the format of the credit instrument must be one that is acceptable in any jurisdiction and freely transferable, able to be settled at maturity in simple terms and is without restrictions other than its maturity conditions. The instrument that immediately comes to mind is the Documentary Letter of Credit or Standby Letter of Credit. However, as the issue is not trade or transaction related most of the terms and conditions do not apply. The simple “London Short Form” version of the Standby Letter of Credit is often utilized for this simple one-year “corporate debt” type obligation. The test is specific and does not contain any restrictions except the time when the credit is valid and can be presented for payment. It is in real terms a time payment instrument due on or after one year and one day from the date of issue, usually valid for a period of fifteen days from date of maturity.

Standby Letters of Credit also serve as substitutes for the simple or first demand guarantee. In practice, the Standby Letter of Credit functions almost identically to the first demand guarantee. Under both, the beneficiary’s claim is made payable on demand and without independent evidence of its validity. The two devices are both security devices issued in transactions not directly involving the sale of goods and they create the same type of problems.

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