Standby letters of credit (L/Cs) are being used by Indian banks and companies as a tool to avert default, according the media reports.

A report in the Economic Times says that the practice is adopted particularly in respect of large borrowers in the steel, pharmaceuticals or energy sectors.

Likely default

According to the newspaper, a standby L/C is employed when both the lender and the borrower consider that default is likely.

The lender then issues a standby L/C on behalf of the company, promising to pay another bank if the company defaults on its payment obligations.

Discounted L/C

If this happens, the company uses a wholly-owned offshore subsidiary to discount the L/C at a foreign bank.

The proceeds of the discounted L/C are then sent to the company in India which then pays its loan obligations to the issuing bank.

According to the Economic Times, the practice is employed by some large public sector banks as well as some private ones.

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