Difference between Bank Guarantee & Letter of Credit

Difference between Bank Guarantee & Letter of Credit

Finance & Accounting

Vishal Terkar

Vishal Terkar

108 week ago — 4 min read

A Bank Guarantee and a Letter of credit are 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 organisation 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 the difference between a Bank guarantee and a 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.

  1. Shipping guarantees

A written guarantee is presented to the carrier in the event of goods arriving before the arrival of the shipping documents.

  1. 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?

A 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 assurance for the funds.

 

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 the buyer’s bank agrees to pay the seller as soon as certain conditions of the transaction are met.

  1. 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.

  1. 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.

  1. 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.

  1. Revolving letter of credit

A single revolving letter of credit can cover several transactions between the same buyer and seller.

 

 

Also read: How to get Project Funding?

 

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Vishal Terkar

As a founder at Terkar Capital, I leverage my expertise in debt financing to empower companies at Terkar Capital. I've facilitated funding for over 400 clients, strategically...

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