Definition of Bank Guarantee
As the name indicates, a guarantee given by a bank on behalf of his customer (account holder) to the beneficiary, for assurance of payment in the event of default by its applicant is called bank guarantee.
Bank guarantee is the usual practice in public tenders/govt related works in domestic markets. Bankers charge commission up to 1.5% per annum on the issuance of bank guarantees.
There are two types of bank guarantees:
Definition of Letter of Credit
A letter of credit is a financial instrument, which is issued by a buyer to the seller, confirming a payment. A typical LC will have certain clause/terms which have to be met by both buyer and seller for the successful execution of the transaction. Basically, for Buyers/Importers, it will clearly mention terms of payment by the seller.
For the seller, it will contain terms like type/quantity & condition of goods & documentary evidence along with relevant shipment bills etc. Once all the terms and condition are met, the bank will transfer funds . This Product is availed by Exporter/Importer.
Types of Letter of Credit
Red Clause L/C
Typical cost of LC can run up to 2% of transaction cost which can be collected under various heads like-
LC Opening Charges
LC retirement Charges
Key Differences Between Letter of Credit and Bank Guarantee
- Guarantee is an instrument given by the applicant’s bank to the beneficiary, confirming payment in the event of default, whereas the Letter of Credit is a payment assurance given by the applicant’s bank, subject to certain terms and condition.
- Under Bank Guarantee, a bank takes responsibility for payment when the client fails to honor commitment. In Letter of credit, Primary Liability lies with the bank to collect payment from the seller.
- The number of parties involved in Bank Guarantees is restricted to the applicant, beneficiary and banker, whereas in case of LC, it can be more than three, i.e applicant, Applicant/issuing bank, beneficiary, advising bank, negotiating bank and confirming bank.
- Bank Guarantee is used for domestic transactions, whereas the letter of credit is used for import/export transactions.
- Under LC, payment is honoured under successful acceptance of terms and conditions. Under bank guarantee, payment is made under default of certain terms and conditions.
More about Bank Guarantee & Letter of credit can be read on-