Which statement best describes the purpose of a standby letter of credit?

• A. A backup payment guarantee drawn upon only if the buyer defaults
• B. An irrevocable payment schedule for open accounts
• C. A type of cargo insurance
• D. A credit facility for international purchases

Answer: (B)

A standby letter of credit serves as a bank’s guarantee to a seller that payment will be made if the buyer fails to meet the contractual obligations. It is not an active payment schedule or a form of insurance; rather, it sits ready to cover a loss if there is non-performance, and the seller can present compliant documents to draw on it. The promise is typically irrevocable, meaning changes aren’t possible without the buyer’s consent, which provides strong assurance to the seller. This instrument is used to reassure suppliers in international deals that they will be paid or compensated even if the buyer defaults, distinguishing it from a regular payment arrangement, cargo insurance, or a general line of credit.