What is the difference between bank guarantee and letter of credit

We help companies to raise finance in ways that is sometimes out of reach for mainstream lenders. Trending Now. Do you export? Take part in our access to finance survey. UK budget: Sunak promises action on HGV crisis, shipping and tonnage tax, warns of further inflation. Letters of Credit Vs. What is the difference between a Bank Guarantee and a Letter of Credit? Letters of Credit — Reducing the Risk involved A Letter of Credit is a promise from a financial institution to honour the financial obligations of the buyer, and this then eliminates any risk of the buyer not fulfilling the payments.

Bank Guarantees — Failure of Contractual Obligations Bank Guarantees help companies mitigate any risk arising from either side of the transaction, and play a large role in facilitating high-value transactions. The Critical Difference Merchants involved in the exports and imports of goods will choose Letters of Credit to ensure delivery and payments.

Variations As they are tailored instruments, Bank Guarantees can come in different forms: Advanced Payment Guarantee — Typically ensures the performance of a commercial contract.

Loan Guarantee — Promises to assume the debt obligation of the borrower if they face default. When anyone trades outside or inside India, sellers often demand a guarantee that they will receive correct payment from the buyer within a specific time frame.

These guarantees instil confidence in the transaction and participating parties. Both terms are used when doing business or transactions with domestic or international companies. These two terminology looks similar, but there is a massive difference between them. A bank guarantee is a service in which the bank guarantees payment to the seller on behalf of its client buyer if the client is unable to pay.

It is generally used in domestic transactions and beneficial when the other seller party does not fulfil contractual obligations. Furthermore, the bank is not obligated to make the payment, and it can refuse to do so if the claim is found to be illegal. A letter of credit is a document that assures the seller that the buyer will pay the seller. It is provided by a bank that guarantees that the seller is paid on time and in full.

This document is given against a pledge of securities or cash. Further, he has to prove the conformity with conditions, by producing documentary evidence along with the relevant shipment documentation. Once the terms and conditions are met, the bank will transfer the funds to the seller. The functions performed by the letter of credit are:. A bank guarantee refers to a contract, wherein the bank gives the guarantee on behalf of the customer to the beneficiary, that the bank will be responsible for payment, in case if the customer defaults in discharging obligations.

In this agreement, the bank acts as a surety, for making the debt good within three working days, if it is not paid by the applicant. These are used to reduce the risk of loss that is attached to the commercial contracts. For doing so, the bank gets a certain amount of commission based on the sum guaranteed. Further, the bank is not bound to make payment, i. There are two types of bank guarantee:.

The points given below are noteworthy, so far as the difference between letter of credit and bank guarantee is concerned:. A letter of credit is widely used in the international trade, but with the passage of time, its usage in domestic trade has also started.

Both instruments provide financial assistance and reduce risk factors and grow global transactions. So, what is the difference? While bank guarantees, on the other hand, are often used in real estate and infrastructure contacts to mitigate the credit risks in the domestic market. Know More! A bank guarantee is also a legal document where the bank or lending institution provides a guarantee to the exporter on the behalf of the importer to pay the full amount on-time for their delivered services in the event if the buyer defaults and fails to do it.

In simple words, a bank guarantee takes place when there is a default or failure made by the customer ie.