A Bank Guarantee and a letter of credit are the promises from a financial institution. A borrower will actually want to reimburse an obligation to another party, regardless of the account holder’s financial conditions. While different, both bank guarantee and letter of credit, guarantee the third party that if the acquiring party can’t reimburse what it owes, the financial organization will step in for the benefit of the borrower. A Bank guarantee is similar to a Letter of credit but not the same. Let’s understand bank guarantee vs letter of credit.
What is Bank Guarantee?
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 the customer defaults in discharging obligations. BG settles the debts of the debtor. Thus, in case the borrower defaults on the loan, the lender promises to pay.
Types of Bank Guarantee:
1. Confirmed Payment Guarantee
This is an irrevocable obligation, with this a specific amount is paid by the bank to a beneficiary on behalf of the client by a certain date.
2. Shipping guarantees
A written guarantee is presented to the carrier in the event of goods arriving before the arrival of the shipping documents.
3. Loan guarantees
An institution that issues a loan guarantee pledges to take on the financial obligation if the borrower defaults.
What is a Letter of Credit?
Letter of credit is a financial document for assured payments. i.e. An undertaking of the buyer’s bank to make payment to the seller, against the documents stated. The bank issues a letter of credit. In case, the buyer makes a default payment, the bank gives a guarantee to pay. So, LC discounting takes away the risk. The seller gets an assurance for the funds.
Learn more from Letter of Credit discounting FAQs.
Types of Letter of Credit
1. Irrevocable letter of credit
An irrevocable letter of credit is a guarantee from a bank, issued in the form of a letter. Thus, an agreement is created. Wherein if the buyer’s bank agrees to pay the seller as soon as certain conditions of the transaction are met.
2. Confirmed letter of credit
This refers to an additional guarantee obtained by the borrower in addition to the first letter of credit from another bank. This is done in case there is an issue with the credibility of the first bank issuing LC.
3. Import letter of credit
Import letter of credit is issued by the importer’s bank on behalf of the importer with the exporter being the beneficiary. A guarantee is given by the importer bank that the payment will be made to the seller/exporter.
4. Export letter of credit
The letter of credit, when received by the exporter’s bank, becomes an export letter of credit. Before the exporter can receive payment, he has fulfilled certain terms and conditions and submitted the required documents as mentioned in the letter of credit.
5. Revolving letter of credit
A single revolving letter of credit can cover several transactions between the same buyer and seller.
Bank Guarantee vs Letter of Credit - Key Difference
| Bank Guarantee | Letter of Credit |
Definition | Bank Guarantee is given by the bank to the beneficiary in case there is a default in payment by a borrower | LC is a financial document for assured payment. |
Parties Involved | 3 Parties namely the issuer, banker, and the beneficiary (third party). | 4 Parties namely LC Issuing bank, the issuer, the beneficiary (third party), and advising bank. |
Nature of business | Government contract | Import-Export |
Default | Becomes active when burrower makes default in payment | Doesn’t wait for applicants to default |
Payment | Done when an obligation is not fulfilled. | Payment is made when certain conditions are fulfilled |
Risk | Customers assumes risk primarily | Bank assumes the primary risk |
Liability | Bank only make the payment when burrower makes default in payment | Bank holds primary liability and makes the payment and then collects it from the customer later |
Why choose Terkar Capital?
Terkar Capital provides top investment banking services in India. We consult the aspiring entrepreneurs and promote seamless funding solutions to them. We arrange and provide a wide range of products as per the clients’ needs and expectations. Our team of experts constantly guides the clients in each and every step of the funding process. Thus, preserve the confidentiality of the respective clients.
Learn more about bank guarantees Vs letters of credit.
