Money & Finance › Payments & money movement › Trade finance and payment guarantees: getting paid safely
Standby letters of credit and bank guarantees
ISP98 rules, 1998· Asset or instrument
Fact, law or dataA rule, statute, definition or measured number.
A bank's promise to pay a beneficiary if its customer fails to pay or perform: backup security, not the normal way to pay.
See it on the Money & Finance map →How it works
A tenant, contractor or borrower (the applicant) has its bank issue a standby naming the landlord, owner or lender as beneficiary. On default, the beneficiary presents a demand and a signed statement of default, and the bank pays, usually within days, without judging the underlying dispute. The applicant pays roughly 1–3% a year and usually pledges cash or uses a credit line. US banks long could not issue guarantees, so standbys filled that role; most follow ISP98 rules.
Why it matters
It turns a promise into near-cash security: for a landlord or lender, the bank's credit replaces the tenant's or borrower's.
Think of it like
Like a security deposit held by a bank instead of the landlord: the tenant keeps its cash, and the landlord can still collect on default.
Facts, rules and data
ISP98 (ICC Publication 590, effective 1999), UCC Article 5, the ICC's URDG 758 rules for guarantees used abroad, and bank call reports listing standby letters of credit outstanding.
Debates and risks
Whether a bank will pay smoothly when its own health is in doubt, a fear many landlords felt when Silicon Valley Bank failed in March 2023.
Connections (3)
▸Standby letters of credit and bank guarantees pay only on default, unlike Commercial letters of credit (UCP 600) and confirmed LCsFact, law or data
The connection
A commercial LC is the planned way to pay: the bank pays when shipping documents arrive. A standby is a backstop: the bank pays only if its customer fails, against a demand stating default. Both stand apart from the underlying deal, but most standbys are never drawn, while commercial LCs nearly always are.
When and why
Standbys spread in US banking from the 1970s because national banks generally could not issue guarantees; ISP98 rules followed in 1998.
How we know
Bank capital rules (Basel conversion factors: 20% for short-term trade LCs, 50% or 100% for standbys), ISP98 and UCP 600.
Debates and risks
How much standby exposure banks carry off balance sheet in a downturn, when many are drawn at once, is hard to see from outside.
▸Standby letters of credit and bank guarantees often replace cash security deposits in Real estate as an investmentFact, law or data
The connection
Office and industrial tenants often post a standby, sometimes several months to a year of rent, instead of a cash deposit. The tenant keeps its cash; the landlord draws by presenting a demand if rent goes unpaid. Landlords commonly require an 'evergreen' renewal clause, the right to draw if it lapses, and transferability to a buyer or lender.
When and why
Common in US commercial leases, especially with tech and startup tenants; Silicon Valley Bank's 2023 failure tested many such letters.
How we know
Standard lease forms and lender requirements, ISP98, and coverage of how the FDIC's bridge bank kept SVB letters of credit in force.
Debates and risks
Courts differ on whether a landlord's draw counts against the bankruptcy-code cap on claims for a rejected lease.
▸Standby letters of credit and bank guarantees often back completion and performance in Construction loans and mini-permsFact, law or data
The connection
Construction lenders and cities want backup if a project stalls. A developer may post a standby for part of its equity or interest reserve; a contractor may post one instead of a performance bond; cities often take one to guarantee streets and utilities. The beneficiary draws if the work or payment fails.
When and why
Common in US development, including California subdivision and public-improvement agreements; the cost is often about 1–3% a year of the face amount.
How we know
Construction loan agreements, municipal improvement-agreement forms that accept letters of credit or bonds, and bank fee schedules.
Debates and risks
Whether a letter of credit or a surety bond better protects owners and lenders, since a surety investigates before paying and a standby pays first.