LC is used in international trade. Here buyer and seller do not know each other. They are used in the terms of exporter and importer.
What are LC and BG i.e. Letter of Credit and Bank Guarantee and what is the difference between them. Both these are non-fund based credit facilities. Which a bank gives mostly inside trading finance. Some people think of both as the same instrument, while they are very different and used in different places.
What is Bank Guarantee (BG)?
When a buyer and seller enter into an agreement in which the seller-buyer can also sell goods, someone wants to work with him through a contract, or there can be an agreement between a contractor and a tendering agency.
In this situation, the seller does not immediately trust the buyer, so he asks the buyer for a performance guarantee that if both of them will work together and if there is any mistake by the buyer, then the seller will take his compensation from the buyer’s performance guarantee.
In this case, the buyer will request a bank to guarantee that if there is any mistake by the buyer, the bank will compensate the seller.
What is Letter of Credit (LC)?
LC is generally used in international trade. Here buyer and seller do not know each other. Mostly it is used in the terms of exporter and importer.
In this, it tells the seller-buyer that I will transfer the goods to you when you give me a letter of credit. In this case the buyer requests a letter of credit from the issuing bank (buyer’s bank).
When the issuing bank accepts the buyer’s request, it sends a letter of credit to the advising bank, which is the seller’s bank. Then the advising bank sends the letter of credit to the seller, so that the seller is satisfied that the buyer is now serious about the business. Then the seller supplies the goods to the buyer. In this condition the advising bank gives the money to the seller and the issuing bank pays to the advising bank and the buyer pays to the issuing bank.
What is the difference between Bank Guarantee and LC?
There is a difference in letter of credit and bank guarantee that in LC payment transaction happens first, but in bank guarantee when the actual transaction takes place when buyer fails to pay.
There is one type of transaction in LC and it is a kind of surety. This is a type of security and not a transaction.
Bank Guarantee is not only used in buying and selling any goods, but it is also used in government tenders, in private tenders as well. Letter of credit on the other hand is mainly used in international trading.
Banks check the relationship of the buyer with the bank, timely payment, balance sheet etc. before issuing BG and LC.
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