Bank Guarantee Vs Letter Of Credit | What is the Difference?, BGs Vs LCs, Examples, Benefits and Limitations

Bank Guarantee Vs Letter Of Credit: A kind of guarantee from a lending organisation is called a bank guarantee. If a lender (customer) fails to repay his debts or loan, the bank takes the responsibility to pay the amount. A bank guarantee enables the debtor to purchase goods and draw down loans. It also helps in business growth and promotes entrepreneurial events. There are different kinds of bank guarantees which includes direct and indirect guarantees.

Banks offer direct guarantees in domestic and foreign ventures whereas indirect guarantees are generally associated with government agencies and practices. If we talk a letter of credit, also known as a credit letter is a document from a financial institution in which certain payments were made during a business transaction. This process involves a third party in the transaction. In this, the applicant needs to partner with a lender to secure a credit letter. The procedure is similar to applying for a loan and applicants also need to wait for the approval. Sometimes an applicant needs to work with a specific branch of a bank. There are different types of credit letters such as a commercial letter of credit, standby, revolving letter of credit, traveller’s letter of credit, and confirmed letter of credit.

Get Other Types of Letter Writing like Formal, Informal and Different Types of Letter Writing Samples.

Comparison Table on Bank Guarantee Vs Letter Of Credit

Let’s compare a bank guarantee with a letter of credit;

Comparison Based On Bank GuaranteeLetter Of Credit
DefinitionA guarantee is given by the bank to the beneficiary when the applicant is unable to pay a certain amount if the applicant defaults in payment.A letter of credit is a financial document for payments. Usually involves business transactions that are an undertaking of the applicant’s or buyer’s bank to make payments to the seller.
Risk factorThis risk is more for merchants and less for banks.This risk is more for banks and less for merchants.
The intervention of partiesThree parties can involveMore than five parties can involve.
LiabilitySecondaryPrimary
Suitable purposesSuitable for government contracts.Suitable for business especially for import and export.
DefaultInvolve actively only when the applicant’s default is making payment.Never waits for the applicant’s default.
Payment procedurePayment is made anyway as it does not require any fulfilled condition.Payment is made only after the fulfilment of certain conditions.

Bank Guarantee Vs Letter Of Credit

Examples Of Bank Guarantees

They are as follows;

  • A payment guarantee assures a seller the price of purchase is to be paid according to the given date.
  • An advance payment guarantee pledges to reimburse advance payment from the buyer when there is no supply of the goods as per the contract of the seller.
  • A rental guarantee act as collateral for various agreement payments.
  • A warranty bond serves by ensuring goods that have been ordered are delivered on time.
  • In a confirmed payment order, the bank pays the beneficiary a set of amounts on the behalf of the client.
  • Credit security happens to repay a loan.

Benefits And Limitations Of A Letter Of Credit

A letter of credit has both benefits and limitations, let’s study in detail;

Benefits

  • Security is provided for the sellers in deals because if the customer could not able to pay even then the sellers can get paid without any problem.
  • It creates an environment of security in transactions and also builds trust, especially during international trade deals, where parties are unaware and unknown in every aspect.
  • It also provides written guidelines in a detailed form which help to understand money transactions.
  • Third parties are involved in this process which makes the exchange of money efficient compared to directly visiting the buyer and seller.
  • It is customizable and can easily satisfy the terms of individual deals.

Limitations

  • It costs a fee for the buyer to obtain any kind of deal.
  • All the transactions were not covered.
  • Does not covers the mitigating situations in the transactions like political issues, inflation affecting foreign exchange rate or supply chain issues, etc.
  • It is a time-consuming process for both parties which are involved.

Bank Guarantee Request Letter

Date

To,

The Branch Manager,

ICICI Bank Ltd.,

Branch XYZ

Subject: REQUEST LETTER FOR ISSUING BANK GUARANTEE

Respected Sir/Madam,

We solicit you to issue a bank guarantee as per format. We also request you to debit charges and/or limit to our Cash Credit Account / Current Account No:XXXXXXXXX  along with your charges. The bank guarantee is to be issued against our limit of ` ————–/ The bank guarantee is against the full cash limit given by us.

Bank Guarantee Amount: XYZ

Beneficiary Full name and address:(For Bank’s Control Purposes): XYZ

BG Expiry Date: XYZ

BG Claim expiry date (If any): XYZ

DECLARATION – CUM – UNDERTAKING ( In case of foreign bank guarantee only)

I/We declare that the transaction the details of which are specifically mentioned in this request letter does not involve, and is not made for the purpose of any contravention of the provisions of the Foreign Exchange Management Act or of any norms and regulation, notification, direction or order made thereunder. I /We also agree and undertake to give such details/documents as it will satisfy you about this transaction in the matter of the above declaration. I/We also understand that if I/We refuse to obey any such requirement or make only undesirable adherence therewith, the bank shall refuse in writing to undertake the transaction and shall if it has reason to believe that any violation is contemplated by me/us report the matter to RBI. I/We hereby confirm that the undersigned has the authority to give this declaration and undertaking on behalf of the company.

Thanking You,

Yours faithfully,

For…………………………………………….

AUTHORISED SIGNATORY/IES

Bank Letter Of Credit Format

Date: dd-mm-yyyy (Date of writing the letter)

From

Name

Address

To

Name of the recipient

Address

Subject: Issuing of credit letter

Dear Sir/ or  Madam,

I am XYZ  writing this application to you in support of (XYZ BANK NAME). You are at this instant informed that our bank had issued a letter of credit in your name for INR XXXXX. The letter is valid till ____XXXXXX________.

The termination or expiry date will not get an extension unless the authorized bank gives it in a written form. If the bank gives notice in a written form for extending the date, then the date will be considered as per the rules and regulations specified.

(Paragraph regarding the rules and commission)

(A notification of the letter should be there about the ACT)

Thanking you.

Regards

(Name of the Applicant)

FAQ’s on Bank Guarantee Vs Letter Of Credit

Question 1.
What do you understand by home lien?

Answer:
It is a legal claim made on a home.

Question 2.
Mention the different types of bank guarantees?

Answer:
There are two major types of bank guarantee a financial bank guarantee and a performance guarantee.

Question 3.
What are the major four types of credit letters?

Answer:
The four major types of letters of credit are a revocable letter of credit, commercial letter of credit, irrevocable letter of credit, standby letter of credit and red clause letter of credit.

Question 4.
Who is known as the beneficiary?

Answer:
The person of the company who will be paid under the guidelines of the letter of credit.

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