Standbys without Expiration - Disagreements
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Standbys without Expiration - Disagreements

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On Standbys without Expiration Dates, Consider This Point

Documentary Credit World reader feedback has expressed disagreement with the statement in the Update on “Standbys without Expiration Dates” (Oct 2022 DCW 4) that “It is a violation of the Safety & Soundness regulations applicable to US banks (12 CFR 7.1016) to issue letters of credit (including demand guarantees) without expiration dates UNLESS the bank is cash collateralized.”

The regulation does not actually state that.  7.1016(b) deals with safety and soundness “considerations.” Banks are required to consider under clause (iii) that “The undertaking should: (A) Be limited in duration; or (B) Permit the bank to terminate the undertaking …; or (C) Entitle the bank to cash collateral … .”  (Emphasis added). Some recall that an early draft version of the regulation used “must” but this was softened to “should.” 

In any event, the US Office of the Comptroller of the Currency (OCC) has explained the difference between “must” and “should” in this context:

“One commenter recommended that the OCC reinforce that the risk management considerations outlined for letters of credit and independent undertakings in § 7.1016 are not mandatory safety and soundness conditions by removing them from the text of the rule.  The OCC disagrees.  Section 7.1016(b) provides safety and soundness considerations for banks that issue independent undertakings.  Section 7.1016(b)(1) states that, as a matter of safety and soundness, banks that issue independent undertakings should not be exposed to undue risk and should, at a minimum, consider the following before issuing independent undertakings: (1) Whether the terms make clear the independence of the undertaking; (2) whether the amount of the undertaking is limited; (3) whether the undertaking is limited in duration or, if not, whether the bank has an ability to end the undertaking or demand cash collateral from the applicant; and (4) whether the undertaking will be collateralized or include a reimbursement right.  Section 7.1016(b) provides additional considerations in special circumstances to protect against credit, operational, and market risk.  Section 7.1016(b)(3) states that the national bank or Federal savings association should possess operational expertise that is commensurate with the sophistication of its independent undertaking activities.  By using the word “should,” these provisions clearly indicate that the listed safety and soundness considerations are not mandatory.  Furthermore, the OCC finds that it is helpful to include these recommended considerations in the rule text so that national banks and Federal savings associations understand what the OCC may consider to be undue risk.”  [85 FR 83686, 83692; 22 Dec 20 (emphasis added).]

 
Clearly a national bank subject to OCC regulation should not lightly issue a letter of credit without an expiration date, and if it does issue a credit without an expiration date it should be prepared to defend why that was reasonable in the circumstances.  E.g., the amount of the credit might be small, the applicant might be a top company, and the beneficiary might be reputable and creditworthy and obligated promptly to surrender the credit for cancellation when the underlying obligation supported by the credit has been performed by the applicant or the credit has been replaced by other credit support.

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This excerpt was taken from the 2022 October issue of Documentary Credit World.  Sign up for a free trial issue here.

 

 

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