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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