Letter of Credit vs. Bank Guarantee: What's the Difference?
Edited by Harlon Moss || By Janet White || Published on November 12, 2023
A Letter of Credit assures payment to the seller, contingent on delivering goods/services, while a Bank Guarantee ensures compensation upon failure to fulfill contractual obligations.
Key Differences
A Letter of Credit is a financial instrument issued by a bank or financial institution to ensure that a seller receives payment for goods or services. It acts as a guarantee that the buyer's payment to the seller will be made on time and for the correct amount. On the contrary, a Bank Guarantee is a promise from a bank or financial institution to compensate the beneficiary in the event that the obligor fails to fulfill their contractual obligations.
While a Letter of Credit primarily deals with the facilitation of international trade by providing security to both parties in a transaction, a Bank Guarantee is more versatile and can be used in various scenarios, including both domestic and international settings, to ensure the performance or financial obligations of a party.
The Letter of Credit benefits both the buyer, who ensures that the goods or services are delivered as agreed, and the seller, who is assured of payment upon meeting the terms. In contrast, a Bank Guarantee is more tilted towards the beneficiary, ensuring they are not at a loss if the other party defaults.
Typically, a Letter of Credit is product-specific, meaning it's tied to the sale and delivery of specific goods or services. In comparison, a Bank Guarantee is broader and can cover any kind of obligation, from lease agreements to construction projects.
In essence, while a Letter of Credit is a payment assurance mechanism, a Bank Guarantee is an assurance of compensation in the case of non-performance or default.
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Comparison Chart
Primary Purpose
Assure payment upon delivery of goods/services
Ensure compensation upon non-fulfillment of obligations
Application
Mainly international trade
Versatile - both domestic and international scenarios
Beneficiary
Both buyer and seller
Mainly the party expecting fulfillment of obligations
Specificity
Tied to specific products/services
Can cover a broad range of obligations
Nature
Payment assurance mechanism
Compensation assurance for non-performance
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Letter of Credit and Bank Guarantee Definitions
Letter of Credit
A document ensuring payment upon meeting specified conditions.
The supplier agreed to the terms once presented with a confirmed Letter of Credit.
Bank Guarantee
A commitment by a bank to compensate for defaults.
The distributor demanded a Bank Guarantee before signing the long-term deal.
Letter of Credit
An instrument facilitating international trade by ensuring payment.
To secure the deal, the importer offered a Letter of Credit from a renowned bank.
Bank Guarantee
A guarantee assuring the beneficiary of compensation.
To ensure timely delivery, the buyer requested a Bank Guarantee from the supplier.
Letter of Credit
A bank's promise to pay the seller on behalf of the buyer.
The exporter shipped the goods, trusting the buyer's Letter of Credit for payment.
Bank Guarantee
An assurance of payment in case of non-performance.
To rent the venue, the event organizer provided a Bank Guarantee.
Letter of Credit
A financial tool reducing risks in trade transactions.
The trader always preferred deals backed by a Letter of Credit for added security.
Bank Guarantee
A bank's promise to cover losses if a party defaults.
The contractor secured the project backed by a Bank Guarantee ensuring timely completion.
Letter of Credit
An assurance to the seller that the buyer's bank will pay.
With a Letter of Credit, the manufacturer was confident about the transaction.
Bank Guarantee
A tool protecting against breaches in agreements.
The landlord was reassured with the tenant's Bank Guarantee against potential damages.
FAQs
Can a Letter of Credit be used in domestic transactions?
While commonly used in international trade, a Letter of Credit can also be used in domestic transactions.
Who benefits most from a Bank Guarantee?
The beneficiary, often the party expecting the other to fulfill obligations, benefits most from a Bank Guarantee.
Who pays the fees associated with issuing a Letter of Credit?
Typically, the applicant or buyer pays the fees, but it can vary based on the agreement.
In what scenarios is a Bank Guarantee typically used?
Bank Guarantees are used in diverse scenarios, from construction projects to lease agreements.
Can a Bank Guarantee be transferred to another party?
Some Bank Guarantees are transferable, but it depends on the terms stated in the guarantee.
What happens if the terms of a Bank Guarantee aren't met?
If the terms aren't met, the beneficiary can claim the guaranteed amount from the bank.
What kind of transactions typically require a Bank Guarantee?
Transactions where there's a risk of non-performance or default, such as large contracts or rentals, often require a Bank Guarantee.
What's the main purpose of a Letter of Credit?
A Letter of Credit ensures that sellers receive payment for goods/services upon fulfilling terms.
Why would a business prefer a Letter of Credit over direct payment?
A Letter of Credit reduces payment risks by ensuring payment upon meeting specific terms.
Is a Letter of Credit safe for both buyers and sellers?
Yes, a Letter of Credit offers security to both parties in a trade transaction.
Can a Bank Guarantee be extended?
Yes, with the consent of all parties, the Bank Guarantee's duration can be extended.
Can any bank issue a Bank Guarantee?
While most banks can, the capability and terms might differ based on the bank's policies and the transaction's nature.
Can a Letter of Credit be confirmed by another bank?
Yes, a confirming bank can add its assurance to a Letter of Credit, increasing its security.
What happens if a bank that issued a Bank Guarantee goes bankrupt?
If the issuing bank becomes insolvent, the beneficiary can still claim the guaranteed amount, depending on the jurisdiction and specific terms.
Can the value of a Letter of Credit be modified?
Any modification requires consent from all parties involved, including the issuing bank.
Who issues a Letter of Credit?
A bank or a financial institution issues a Letter of Credit.
What's the cost of obtaining a Bank Guarantee?
The cost varies based on the bank, the guarantee amount, and the transaction's risk.
Is a Letter of Credit revocable?
Unless specified as revocable, most Letters of Credit are irrevocable, meaning they can't be changed without all parties' consent.
What's the difference between a Bank Guarantee and a security deposit?
While both provide assurance, a Bank Guarantee is a promise by a bank to cover losses, whereas a security deposit is an actual amount held to cover potential damages.
How long is a Letter of Credit valid?
The validity varies, but it's defined in the Letter of Credit itself.
About Author
Written by
Janet WhiteJanet White has been an esteemed writer and blogger for Difference Wiki. Holding a Master's degree in Science and Medical Journalism from the prestigious Boston University, she has consistently demonstrated her expertise and passion for her field. When she's not immersed in her work, Janet relishes her time exercising, delving into a good book, and cherishing moments with friends and family.
Edited by
Harlon MossHarlon is a seasoned quality moderator and accomplished content writer for Difference Wiki. An alumnus of the prestigious University of California, he earned his degree in Computer Science. Leveraging his academic background, Harlon brings a meticulous and informed perspective to his work, ensuring content accuracy and excellence.
