A letter of credit and bank guarantee are the terms used in the context of banking, while both terms imply that the bank will come to the rescue of the seller if the account holder of the bank is unable to honor his or her obligation. However, there are many differences between the two terms lets look at some of the difference between the letter of credit and bank guarantee –
Letter of Credit Vs Bank Guarantee
Meaning
A letter of credit refers to that facility where the bank agrees to pay to the exporter of the goods in the event of the importer not paying to the exporter within a stipulated period of time. In simple words, in the case of a letter of credit if the importer is not able to pay to the exporter then the importer’s bank will have to pay to the exporter. Bank guarantee refers to that facility where the bank agrees to make full payment to the party in whose favor guarantee is issued if the person taking the guarantee is not able to fulfill the contractual obligations whether it’s financial or performance-related.
When it is Taken
Letter of credit is taken while doing international trade but as far as a guarantee is concerned it can be taken both for domestic purpose and international purpose. In simple words, the letter of credit is taken when the party is dealing in foreign markets for imports and exports whereas a guarantee can be taken by anyone who is dealing with contractual work.
Types
Letter of credit is of many types such as a revocable letter of credit which can be canceled by the issuing bank at the request of the importer, irrevocable letter of credit which once issued cannot be canceled by the issuing bank, revolving letter of credit where the letter of credit works like a credit card, back to back letter of credit where one letter of credit is opened with another letter of credit as security and deferred letter of credit. While bank guarantee is of two types while one is financial guarantee where bank guarantees that the buyer will repay the debts to the seller and in the event of non-payment by the buyer bank will be liable to pay to the seller and other is a performance-based guarantee under which bank agrees to compensate for the damages in the event of non-performance by the concerned party.
Parties Involved
In the case of a letter of credit, there are 4 parties involved that are importer, exporter, importers bank, and exporter’s bank while in the case of bank guarantee there are only three parties that are the bank, the person who has to perform the contract or on whose behalf bank has given guarantee and third is the individual or corporate entity to which guarantee is given.
Dealings
In the case of a letter of credit importers bank will not deal with the exporter directly rather it will deal with the exporter’s bank whereas in the case of a guarantee the bank will deal with the beneficiary of the guarantee directly. In simple words in the case of LC dealings are between banks while in the case of bank guarantee dealing is between the bank and the concerned party.
Assurance and Insurance
Letter of credit acts as an assurance to the exporter that he or she will receive the payment for the exports due to backing by the importer’s bank through a letter of credit while bank guarantee acts as an insurance cover as in the event of non-payment of dues as in the case of financial guarantee or non-performance as in the case of performance guarantee bank will compensate the party in whose favor bank guarantee is given.
As one can see from the above that there are many differences between LC and bank guarantee and that is the reason why any company thinking of taking LC or bank guarantee should first carefully read the above differences and then only should take the decision regarding taking LC or bank guarantee from the bank.