You may be wondering what are the benefits of leasing a banking instrument or considering other options besides risking your own collateral to secure a line of credit.
The benefits of leasing an SBLC:
-
It is very good for trade finance.
-
It is good to provide comfort to the Seller if the Buyer does not pay for the received goods
-
It is a good way for a Buyer to buy goods to sell to a Buyer waiting behind the scenes and use the proceeds from the sale to pay for goods purchased from the Seller.
How does leasing an SBLC work?
Let’s say you are a factory that converts soybeans into soy milk. You have an order from the local supermarket for $ 150 million, you want to buy $ 100 million worth of soybeans from a supplier, you have $ 250 million in your bank account.
You may be concerned that with other outgoing costs, this order could leave you with very little money for other expenses. Instead of taking the entire $ 100 million out of your bank account to deposit as collateral for a loan to buy the soybeans, you can choose another (safer) option.
You could set up a banking instrument to show your Supplier that you have the financial means ready to buy the soybeans from them. This banking instrument will come from a third-party provider that will allow you to lease your collateral at, say, 10% of the cost, so now you’re only spending $ 10 million instead of risking $ 100 million. Leasing a bank instrument means that you are a temporary tenant for one year and one day.
Typically, invoices are issued on a 45-, 60-, or 90-day billing cycle. So, theoretically, you could buy the soybeans from the Supplier by taking out a bank instrument. This would then be assigned to the supplier as a backup in case they fail to pay the invoice settlement; This is very common in commercial financing.
In commercial financing, the Provider will want guarantees through a banking instrument to demonstrate that, in the event that an invoice is not settled, they can request the instrument and collect it to collect their payment. If this is timed correctly, the Buyer of the soybean can receive the merchandise, convert it into soy milk to sell in the supermarket, who in turn pays the $ 150 million that have been previously agreed and the Supplier in turn can liquidate the $ 100 million. (the cost of the Supplier’s soybeans) within the stipulated timeframes and risking very little of your own money.
Example of leasing an SBLC:
Vendor sells soybeans for $ 100 million
The buyer leases a bank instrument at 10% of the nominal value of the instrument. Therefore, the cost of the lease in this case is $ 100 million x 10% = $ 10 million.
The buyer presents the instrument as a ‘promise to pay’ in the event that the buyer fails to pay the $ 100 million bill and the supplier proceeds to supply the soybeans.
The buyer takes the shipment of goods and processes the soybeans into soy milk
The buyer then immediately sells the soy milk to the supermarket for $ 150 million.
Supermarket Settles $ 150 Million Bill Immediately
The buyer then takes the $ 150 million and liquidates the $ 100 million immediately and makes a profit of $ 40 million ($ 150 million less $ 100 million less $ 10 million for the cost of leasing the instrument) without having to provide the $ 100 million upfront. The entire transaction essentially cost them $ 10 million and they managed to earn $ 40 million in the process.
Buy an SBLC
If you are looking to buy an SBLC, there are some pros and cons to know about. The main advantage of purchasing a StandBy letter of credit is that you become the official owner of the instrument and in turn can lease the bank instrument to a third party. It should be noted that the price of the banking instrument will not be cheap, since the purchase cost would start at around 30% more than the face value. So if you want to buy a StandBy letter of credit for $ 100 million, the purchase price would start around $ 30 million, so you will need to weigh the benefits of purchasing a bank leased instrument from v.