Bank Guarantee and Letter of Credit are two financial instruments that are very helpful to buyers and suppliers, especially when they are not too well known to each other or are just starting out on a venture. These two financial instruments are issued by banks to buyers and sellers and have many common features. However, there are many differences that will be highlighted in this article.
What is Bank Guarantee?
Bank Guarantee is like a financial cover to the supplier for recovering losses or damages. It is issued by the bank on the request of the buyer and given to the supplier. When the buyer defaults on payments or there is any dispute between the two parties, the buyer can instruct the bank to invoke the bank guarantee and recover the payment mentioned in the instrument. It insures the supplier against losses if the buyer fails to fulfill his part of the obligation. When the buyer fails to pay the seller for goods he has supplied, the seller can ask the bank for the amount mentioned in the Bank Guarantee and the bank is obliged to pay the beneficiary the aforesaid amount. A Bank Guarantee is used in situations where the two parties are relatively unknown and are entering upon a contract.
What is Letter of Credit?
A Letter of Credit is more commonly used in international trade where the supplier is in one country and the buyer is in another. This is a financial instrument that guarantees a supplier that he will receive payment for the goods in time and for correct amount. If the buyer does not pay in full, or makes delays, the bank undertakes to pay the difference or the full amount to the supplier. Even a buyer can ask the issuing bank not to pay the supplier until he is sure of the goods having been shipped.
What is the difference between Letter of Credit and Bank Guarantee?
Major difference between Bank Guarantee and Letter of Credit is that the issuing bank does not wait for a default from the buyer unlike Bank Guarantee where a formal request is made by the supplier to this effect. Bank Guarantee is therefore called a second line of defense while LC guarantees timely payments for the supplier. LC is more of an obligation on the part of the issuing bank that has to transfer the funds once criterion mentioned in the contract are fulfilled. Letter of Credit is thus more for ensuring timely and correct payments.
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