www.graincon.com
Standby letters of credit are much too exciting to be left to professors of law and advocates alone. It is the tool that every business must come across in a way or another. Today, banks maintain books exceeding tens of billions of dollars worth of standby letters of credit. It is becoming the instrument that almost effect every thing we see; contractors need performance standby letters of credit to construct huge towers, schools, museums, oil platform, airport terminals, compounds, commercial markets; governments use them to effect payment of principles and interest of their treasury bonds and similar securities; insurance companies use them to compensate their insurers whenever needed …etc. The wide use of standby letters of credit around the world makes it more challenging to study. Some say it could even replace the commercial letters of credit, a hypothesis that may turn true if an exchange mechanism that enhances the buyer's and sellers' level of safety can be somehow engineered.
The world of letters of credit is actually BASED on these two distinctive instruments; commercial LCs and standby LCs. Whilst the international banking practices of the commercial letters of credit continue to change from time to time, the international banking practices pertained to standby letters of credit remain constant or vary insignificantly. This is because of the nature of the two instruments; the former is often used in international import-export transactions where the buyer and seller both require a full level of security over goods and payment, whilst the latter is used in a vast number of situations where the issuer becomes obliged to honour the beneficiary's claim often by the mere presentation of a simple demand and regardless of the applicant's financial situation or reservations. This in principle is an uncomplicated and straight forward function of standby letters of credit. Additionally, the simplicity of the stipulated documents and sophistication of those banks that handle them make the standard practices constant and stable. It is for this reason that global banks around the world continue to rely on the fixed local laws and the ISP98 as the sources of authority that govern the standby LCs transactions without really worrying about any trivial variations in practices.
Even for the UCP600, the newly revised set of rules have not positively impacted the financial results or performance of many second and third tier banks that previously used the UCP500, as for first tier banks, the performances remained within the average trend parameters. The question then becomes, was the revision really warranted? With all the money and time spent on it, one would have expected a lesser sets of discrepant documents and eventually a higher number of commercial LCs and better financial performance; unfortunately the case was not so in many parts of the world.
The revision was focused on sculpturing the banking practices of leading international banks in highly developed regions of stable socio political environments and did not take into consideration the risk factor components of other less developed regions. The Middle East where the ICC's rules of practice can not be applied in full is the most obvious example. Adversely, an ISP98 revision would have a catastrophic impact on banks operating in leading economies such as those of the USA, Europe and UK where they maintain books worth of hundreds of billions of dollars. Naturally said impact would not be apparent in the immediate aftermath of the revision, but probably after one or two years time. There are many reasons for that, but most importantly are the following:
a. The banking practices related to standby LCs have not varied significantly. Hence, it would be a waste of time, efforts and money to become indulged in a lengthy revision process especially this time where certain leading economies are facing serious problems in their banking systems.
b. Global banks have over the years developed highly sophisticated operating systems to detect and prevent fraudulent and money laundering transactions. These systems are partly based on the ISP98 set of rules. Any change in these rules would not only compromise the banks' internal ability to control fraudulent transactions, but would also allow fraudsters a good opportunity to promptly adjust their techniques whilst the banks are adjusting their system and thus availing the formers of a better chance to penetrate the banks' safeguards and execute their frauds or launder their money.
c. With books exceeding $200 billions, banks would rather avoid the chaos of any operational amendments that may reflect negatively on their relationship with their customers and consequently cause them a drop in their market share.
d. Banks would also prefer to reduce the real cost of training which comprises of, in addition to the training fees, the time and effort the staff and their institutions would have benefited from had they been indulged in other activities. On a national level, that would be huge.
In summary, the operations of issuance, advising, perusing documents and settlements are truly complex. The demand to strike a balance between dwarfing risks and growing magnitude will place those financial institutions extensively dealing with standby letters of credit under huge burden that they may not survive if an unwarranted change in the ISP98 rules took place; practice varies vastly from theory in many parts of the world.
