You may be wondering what the benefits are of leasing a bank 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 give the Seller peace of mind in case the Buyer does not pay for the goods received.
- It is a good way for a Buyer to purchase goods to sell to a Buyer waiting in the wings and use the proceeds of the sale to pay for the goods purchased from the Seller.
How does leasing an SBLC work?
Let’s say you are a factory that turns soybeans into soymilk. You have an order from the local supermarket worth $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 put up as collateral for a loan to buy the soybeans, you can choose another (safer) option.
You can obtain a bank instrument to show your Supplier that you have the financial means ready to purchase the soybeans from them. This bank instrument will come from a third-party provider that will allow you to lease your collateral at, say, 10% of 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 a year and a day.
Invoices are typically issued on a 45, 60 or 90 day billing cycle. So, in theory, you could buy the Supplier’s soybeans by taking out a bank instrument. This would then be assigned to the provider as a backup in case they don’t pay the invoice; This is very common in commercial financing.
In trade finance, the Provider will want collateral in the form of a bank instrument to show that in the event of an invoice not being settled, they can claim the instrument and collect it to collect their payment. If this is done at the right time, the Buyer of the soybeans can take delivery of the merchandise, convert it into soymilk for sale to the supermarket, who in turn pays the previously agreed 150 million dollars and the Supplier, in turn, time, you can liquidate the 100 million dollars. (the cost of the Supplier’s soybeans) within the stipulated timeframes and risking only very little of their own money.
SBLC lease example:
Supplier sells soybeans for 100 million dollars
The buyer leases a bank instrument at 10% of the face value of the instrument. Therefore, the cost of leasing in this case is $100M x 10% = $10M
The buyer presents the instrument as a ‘promise to pay’ in the event the buyer fails to pay the $100 million invoice 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 sells the soymilk immediately to the supermarket for $150 million.
The supermarket settles the $150M bill immediately
The buyer then takes the $150 million and liquidates the $100 million immediately and makes a profit of $40 million ($150 million minus $100 million minus $10 million for the cost of leasing the instrument) without having to provide the $100 million up front. The entire transaction essentially cost them $10 million and they managed to make $40 million in the process.
Buy an SBLC
If you’re looking to buy an SBLC, there are a few pros and cons you should be aware of. The main advantage of purchasing a StandBy letter of credit is that you become the official owner of the instrument and, in turn, you will be able to lease the bank instrument to a third party. It is necessary to take into account that the price of the bank 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 at around $30 million, so you’ll need to weigh the benefits of buying a v-lease bank instrument.