Difference between Letter of Credit and Bank Guarantee

Abstract:

Assuming you are a merchant or an importer, utilising a letter of credit can guarantee that your organisation just pays for merchandise after the provider or supplier has given proof that they have been transported.

A letter of credit is a monetary instrument utilised as proof of financial soundness or creditworthiness, given by the bank of the purchaser, concerning his record. L/C is regularly mistaken for a bank guarantee, as they share a few normal attributes like both assume a critical part in exchange financing when the parties to the exchanges don’t have laid out the business relationship.

By and by, the two vary, in the bank’s position vice versa: purchaser and merchant of products and services. A bank guarantee is an assurance given by the bank to the dealer that assuming the purchaser defaults in making payment, the bank will pay the merchant.

Meaning of Letter of Credit:

A letter of credit is a conventional report or a financial document that a bank issues for the benefit of the purchaser to the vendor. The record or the document expresses that the bank will respect the drafts drawn on the purchase or the buyer, for the products provided to him, given the circumstances composed on the archive or document are fulfilled by the provider, supplier, or the seller (merchant).

The vendor or the seller needs to conform to all of the agreements set by the purchaser and expressed in the letter of credit. Further, he needs to demonstrate the congruity and the conformity with conditions by creating narrative proof or by producing documentary proof alongside the important shipment documentation. When the agreements are met, the bank will move the assets to the vendor. The capacities performed by the letter of credit are

Evacuation of credit hazard in the event that the bank has a good standing. Decrease in vulnerability, as the vendor knows about the circumstances which are to be fulfilled to get income. Offers security to the purchaser, who needs to make payment provided that the circumstances referenced in the L/C are met.

Different kinds of letter of credit incorporate Usance L/C, Revolving L/C, Irrevocable L/C, Standby L/C, Confirmed L/C, Sight L/C, etc.

Meaning of Bank Guarantee:

A bank guarantee is concerned with an agreement, wherein the bank gives the assurance in the interest of the client to the recipient or the beneficiary, that the bank will be answerable for payment, in the event that the client defaults in releasing commitments or discharging obligations. In this understanding, the bank goes about as a guarantee, for making the obligation or debt good within three working days, on the off chance that it isn’t paid by the candidate.

These are utilised to decrease the risk of misfortune or losses that are appended or attached to business contracts. For doing as such, the bank gets a specific measure of commission in view of the total ensured. Further, the bank will undoubtedly make payment; for example, it can decline to make the payment assuming the case is seen as unlawful. There are two kinds of bank guarantees; they are

  • Performance Guarantee
  • Financial Guarantee

Difference between Letter of Credit and Bank Guarantee:

LETTER OF CREDIT

BANK GUARANTEE

Meaning

A letter of credit is a monetary archive or a financial document for guaranteed payments; for example, a payment of the purchaser’s bank to make payment to the vendor, against the reports or documents expressed.

A bank guarantee is an assurance given by the bank to the recipient or the beneficiary for the benefit of the applicant to impact payment, assuming the candidate defaults in payment.

Befitting for

Export and import business.

Government contracts.

Remittance

Payment is made only when the condition determined is satisfied.

Payments are made on the non-satisfaction of unsatisfactory commitment.

Non-payment

Don’t wait for the candidate’s default and recipient or beneficiary to conjure or invoke undertaking.

It becomes dynamic or active just when the candidate defaults in making payments.

Included Parties

At least five parties are needed.

At least three parties are needed.

Probability or Risk

More for banks and less for merchants.

Less for banks and more for merchants.

Liability

Essential or primary.

Optional or secondary.

Conclusion:

A bank guarantee is utilised to satisfy different business commitments, by which the bank goes about as a guarantee and ensures the recipient is expected to meet the business necessities. Then again, a letter of credit is broadly utilised in worldwide exchange, yet with the progression of time, its utilisation in homegrown or domestic exchange has likewise begun. Regardless of whether it’s a worldwide market or a nearby one, as a purchaser, you generally need to pay for your purchases, which is worked with by a letter of credit.

Also, see:

Class 11 Accountancy Chapter 8 Bill of Exchange

Functions of the Central Bank

Dimensions of Business Environment

Concept of Business Risk and Its Causes

What Is Commercial Paper

What Is Import Trade

Credit Creation by Commercial Bank

Balance of Payments Surplus and Deficit

Trade Policy and Import Substitution

Intermediate Goods

Fiscal Deficit

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