Can Standby Letters of Credit be Used to Guarantee Loan Repayments?

Standby letters of credit are best known in trade and project finance, but they also sit quietly behind many loan facilities. When drafted as financial standbys or direct pay standbys, they give lenders a bank-backed payment undertaking that supports scheduled principal and interest. The question borrowers and sponsors raise is simple: can an SBLC stand in for a loan guarantee, and if so, what does that actually mean in legal and practical terms?

How Standby Letters of Credit Work In Loan Structures

A standby letter of credit is an independent undertaking issued by a bank or similar provider in favour of a named beneficiary. In a loan context, the beneficiary is usually the lender. The applicant is the borrower or a related party that arranges the standby. The issuing bank promises to honour a compliant demand if the borrower does not meet its payment obligations under the loan.

The key word is independent. The standby does not copy the loan agreement word for word. It references the loan, but the bank examines only the documents that the standby itself requires, not the full history of the credit relationship. The lender’s rights under the loan and its rights under the standby move in parallel. That separation is what makes SBLCs work across borders and under rule sets such as ISP98 or, in some cases, UCP600.

In commercial language, many parties still talk about an SBLC “guaranteeing” a loan. From a legal and operational point of view, the lender actually holds a documentary credit, not a classic suretyship. The effect feels similar for the lender, but the path to recovery runs through document presentation and compliance with the standby text, not through a court claim on the underlying debtor.

Financial Standbys And Direct Pay Standbys For Loan Repayments

When a standby supports loan repayments, it usually falls into one of two patterns: a financial standby that backs up missed payments, or a direct pay standby that sits alongside the primary payment flow and can be triggered at each due date.

For borrowers, the commercial impact varies. A financial standby used as a back-up guarantee may never be drawn if the loan performs. A direct pay standby can influence cash management very directly, because the lender can shift payment collection to the standby bank whenever that suits the agreed mechanics. In all cases, the applicant owes reimbursement to the issuing bank for any drawings, so the risk does not disappear, it simply moves from one credit relationship to another.

Can A Standby Letter Of Credit Actually Guarantee Repayment?

In economic terms, yes. If a reputable bank issues an SBLC in favour of the lender, and the text allows drawing for non-payment of scheduled amounts, then the lender has a strong, demand-based claim that supports repayment. From a pure legal perspective, it is safer to say that the SBLC secures or supports the loan rather than calling it a guarantee in the strict surety sense.

The effect for the lender rests on three things. First, the credit quality of the issuing bank or any confirming bank that adds its name. Second, the clarity of the drawing conditions in the standby text. Third, the alignment between the standby expiry and the loan maturity. Weakness in any of these areas can leave the lender with a document that looks powerful but pays slowly or not at all once a default occurs.

For borrowers and sponsors, this structure can unlock funding where their balance sheet alone would not clear credit approval. They effectively rent the rating of an issuing bank, often backed by cash collateral or other security, to give lenders comfort that contractual payments will be covered even if the borrower runs into problems.

Key Structuring Points For SBLCs Backing Loan Repayments

When a standby supports loan repayments, the text should match the credit story. Lenders, arrangers, and issuing banks each have non-negotiables they look for before they rely on an SBLC in a term sheet or credit approval.

Behind the scenes, the issuing bank will usually demand security from the applicant. That can be cash margin, pledges, guarantees, or claims over project assets. The net result is a chain of risk transfers. The lender relies on the SBLC, the issuing bank relies on the applicant and its collateral, and each party prices its role accordingly.

When Lenders Accept SBLC Support, And When They Push Back

Not every lender treats an SBLC backing a loan in the same way. Some will treat a standby from a top tier bank almost like cash collateral. Others discount the value heavily, especially if the issuer is unfamiliar, lightly regulated, or based in a jurisdiction that raises enforcement concerns.

Where lenders do accept SBLC support, a few patterns recur. Regulated banks prefer standbys issued by other regulated banks or well known financial groups. Funds with a flexible mandate may accept regional issuers, but they often shorten tenor or tighten covenants to compensate. In both cases, the lender’s credit committee usually sets internal limits on the exposure they are willing to take to any single standby issuer.

Lenders push back where the SBLC looks like a backdoor replacement for real equity or where the issuing entity is a lightly capitalised company with “bank” in its marketing but no banking licence. In those situations, an SBLC reference on paper does little for the actual recovery profile, and serious credit teams will either decline or restructure the request.

SBLCs Compared With Guarantees And Parent Support

Borrowers often compare SBLCs with traditional guarantees and comfort letters. Each tool has its place in a capital stack, and lenders weigh them differently when assessing repayment risk.

SBLCs sit in a category of their own because they mix bank credit with documentary rules such as ISP98. For cross-border deals, that can be an advantage. Courts in many jurisdictions have long experience with independent undertakings, and the rules give parties a shared language for how to issue, amend, and draw on them.

When Does An SBLC-Backed Repayment Structure Make Sense?

Using a standby to support loan repayments makes the most sense where there is a gap between the lender’s risk appetite on the borrower and the strength of a bank that is willing to issue the standby. That may be a large international bank, a regional bank with strong local presence, or an insurer working through a fronting bank, depending on the structure.

Typical situations include project sponsors that can post cash or liquid collateral to their relationship bank but need a longer dated facility from a separate lender, trading companies that want to improve terms on borrowing base facilities by adding standby support, and borrowers in emerging markets that bring in a global standby issuer to give offshore lenders more confidence in recovery.

The common thread is that the standby text must match what credit committees think they are approving. Loose drafting that mixes commercial clauses from the loan into the SBLC, or that allows vague defences at the point of drawing, can undo most of the benefit that bank support is meant to provide.

Financely acts as arranger and advisor through regulated partners. Where lending or securities activity requires registration, activity is carried out by or through appropriately licensed firms in the relevant jurisdictions. This article is for general information and does not constitute legal advice, an offer to issue or confirm a standby, or a commitment to provide financing or credit support. Any mandate will be subject to KYC, AML, sanctions screening, full credit approval by issuing and funding counterparties, and formal documentation that sets out the final standby wording, loan terms, and related fees.