How Different Is Bank Guarantee from Letter Of Credit

| September 19, 2012
Bank Guarantee

Bank Guarantee

Anyone who is not so much familiar with the various terminologies used in banks might think that the bank guarantee is same as the Letter of credit. However as far as the bank is concerned, they treat these two terms differently. Many a times even in banks, there will be a certain amount of confusion about these two terms. I am sure many of you too are equally confused and might want to know how they are treated differently.

In short, the purpose of letter of credit or LC is to make sure that transaction goes as per the planning. On the other hand, bank guarantee tries to minimize various losses, if the transaction does not happen as per the plan. Since there is some similarity in their functions, people tend to confuse themselves on these two terms used by bank.

Letter of Credit

As per definition, Letter of credit is considered to be a bank document that any purchaser may demand from any bank in the form of assurance that payment made by him will be delivered to the supplier of goods. This letter assures the supplier that he will receive his payment, which is due to him. Supplier will receive his payment only after submitting the shipping voucher to the respective bank. This will assure the bank that necessary shipment has been made by the supplier as per the agreements.

It is usually used on international transactions so that the risks can be minimized. Potential risks can be many. For example, you may not know all the business laws of a foreign country, custom department rules, and political instability, etc.

You may also consider letter of credit is an obligation on the part of bank given to both party, so that all the necessary criteria will be followed prior to the settlement of payment. When it has been established that all the necessary terms of both sides have been completed, the required payment will be transferred by the bank. Thus letter of credit promises payment for performing the required services.

Bank guarantee

Bank guarantee also ensures the payment to the supplier like the letter of credit. In this case, the bank also guarantees and promises to make payment to aggrieved party in case of any liability, if the terms are not fully met by either supplier or purchaser.

You can now see the big disparity between these two terms used by the banks. In case of letter of credit, it is the responsibility of buyer to make payment after getting the delivery. On the other hand, the bank guarantee ensures the responsibility of the supplier to fulfill the entire obligation as per the agreed terms. In short, both these terms are used to make sure that both parties are fully insured from nonperformance of terms by the other party.

How this helps

After delivery of goods or services, the letter of credit is used. Supplier can therefore request bank to obtain letter of credit before the transaction. Purchaser will buy letter of credit (LC) from bank and send it to the bank of the supplier. Letter of credit will act as replacement of credit for client, so that seller can get his payment in time.

Bank guarantee will be used by seller in case buyer encounters any cash flow problem after obtaining goods or services. This may delay the payment. In such situation bank guarantee will help in making payment to supplier. Also if the seller cannot deliver his services in agreed time frame, then bank will pay the buyer the sum which was agreed in the terms. Bank guarantee thus helps both parties as a safety measure for commercial deals.

Bank guarantee and Letter of Credit allow for smooth business transactions among various countries. By using these options, both the parties can minimize their risks. Anca Ban also writes on critical illness brokers.

How Different Is Bank Guarantee from Letter Of Credit


Category: Finances

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