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what is the difference between bank guarantee and letter of
credit?
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Answer Posted / hanu
While both being non-funded or contingent facilities i.e.
they depend on the happening of a certain event, the basic
difference between the two is that of the parties involved.
In a bank guarantee, three parties are involved; the bank,
the person to whom the guarantee is given and the person on
whose behalf the bank is giving guarantee. In case of a
letter of credit, there are normally four parties involved;
Issuing Bank, Advising Bank, the applicant (importer) and
the beneficiary (exporter).
While appreciating the above. The more comprehensive
response to this question would be a below:
A bank guarantee and a letter of credit are similar in many
ways but they're two different things. Letters of credit
ensure that a transaction proceeds as planned, while bank
guarantees reduce the loss if the transaction doesn't go as
planned.
A letter of credit is an obligation taken on by a bank to
make a payment once certain criteria are met. Once these
terms are completed and confirmed, the bank will transfer
the funds. This ensures the payment will be made as long as
the services are performed.
A bank guarantee, like a line of credit, guarantees a sum
of money to a beneficiary. Unlike a line of credit, the sum
is only paid if the opposing party does not fulfill the
stipulated obligations under the contract. This can be used
to essentially insure a buyer or seller from loss or damage
due to nonperformance by the other party in a contract.
For example a letter of credit could be used in the
delivery of goods or the completion of a service. The
seller may request that the buyer obtain a letter of credit
before the transaction occurs. The buyer would purchase
this letter of credit from a bank and forward it to the
seller's bank. This letter would substitute the bank's
credit for that of its client, ensuring correct and timely
payment.
A bank guarantee might be used when a buyer obtains goods
from a seller then runs into cash flow difficulties and
can't pay the seller. The bank guarantee would pay an
agreed-upon sum to the seller. Similarly, if the supplier
was unable to provide the goods, the bank would then pay
the purchaser the agreed-upon sum. Essentially, the bank
guarantee acts as a safety measure for the opposing party
in the transaction.
These financial instruments are often used in trade
financing when suppliers, or vendors, are purchasing and
selling goods to and from overseas customers with whom they
don't have established business relationships. The
instruments are designed to reduce the risk taken by each
party.
Read more:
http://wiki.answers.com/Q/What_is_the_difference_between_a_b
ank_guarantee_and_a_letter_of_credit#ixzz4QcLJ0S3x
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