What is the Difference Between Letter of Credit and Bank Guarantee?
The primary purpose of a Letter of Credit (LC) is its usage in international trade to ensure payment to the seller upon fulfilling specific conditions, such as delivering goods or services. Guarantees payment to the seller/exporter as long as the terms of the LC are met. Now the primary purpose of a Bank Guarantee (BG) is its usage as a guarantee to cover losses if the borrower fails to fulfill contractual obligations. Ensures compensation to the beneficiary in case of non-performance or default by the applicant. This is the basic difference, however, I have also cited a few more differences for your reference,| Points of Differences | Letter of Credit | Bank Guarantee |
| Parties Involved | Issuing Bank, Applicant (buyer), Beneficiary (seller), Advising/Confirming Bank. | Bank, Applicant (borrower), Beneficiary (seller, supplier, or creditor). |
| Nature of Commitment | An assurance of payment contingent on compliance with the LC terms | A contingent liability where the bank compensates the beneficiary only upon default by the applicant. |
| Risk Coverage | Reduces risk for sellers/exporters by ensuring payment upon presenting required documents | Protects the beneficiary from financial losses if the applicant fails to perform |
| Use Cases | Common in trade finance, especially in international trade transactions | Used in domestic and international business, such as tender bidding, construction projects, or advance payments. |
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Financial assurance for you as a borrower is a bank guarantee or a letter of credit. Both show a third party that the bills will be repaid even if the borrower is unable to come up with the money. In this method, a bank guarantee or a letter of credit reduces risk by providing financial support to you, permitting the trade to proceed. Let me guide you about the bank guarantee vs. letter of credit.
Difference between letter of credit and bank guarantee:
1) Letter of credit
A documentary credit is another name for a letter of credit. A commitment note is a document issued by a financial agency, such as a bank or a non-banking financial company (NBFC). It guarantees that vendors will receive their payment on time and accurately. A financial institution acts as a security for the buyer when it offers a letter of credit.
If the buyer cannot pay the seller, the payment is made by the banking institution. However, banks must meet specified criteria in order to cover buyer charges.
2) Bank Guarantee
A letter of credit has less value than a bank guarantee. A bank guarantee, like a letter of credit, guarantees that banks will pay the money to a specified person if you fail to meet the contract's obligations.
The guarantee can be used by a buyer or seller to secure themselves from harm suffered by the other party's failure to follow through on a contract. Bank guarantees safeguard both parties from credit risk in a valid contract.
This is the difference between LC and BG.
Difference between BG and LC:
Letter of Credit |
Bank Guarantee |
A letter of credit (LOC) is a bank's promise to pay a beneficiary if specific services are completed. |
In the event that the application defaults, the bank guarantees the beneficiary that the payment will be made. |
The bank maintains full responsibility for payment and recovers it from you afterwards. |
When you fail to pay, the bank assumes responsibility for the payment. |
The recipient receives payment from the bank when it is due. It is not necessary to wait for the client to default. |
The bank only pays the payment when you fail to pay the beneficiary. |
The LOC guarantees that the money will be paid as long as the services are delivered according to the contract terms. |
If you fail to meet the required conditions, BG guarantees a refund for the damage. |
The LOC financial institution, its customer, the beneficiary (third party), and the counselling bank are all parties involved in this transaction. |
The banker, its customer, and the beneficiary are the only three people engaged (third party). |
This is more common when importing and exporting products and services. |
It's appropriate for both professional and personal transactions. |
Now you know about the bank guarantee vs. letter of credit.
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Authors Of The Question
Difference between letter of credit and bank guarantee
jignesh
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2 Year
2022-05-16T18:42:26+00:00 2025-01-02T07:15:29+00:00Comment
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