Bank Guarantees and LCs are financial instruments often used in inland or international trade when suppliers or vendors do not have established business relationships with their counterparts. The difference between the two instruments is the position of the bank relative to the buyer and seller of goods or services. The difference is as explained below.

A letter of credit is a bank’s DIRECT undertaking to the supplier (called the beneficiary) to pay. When a letter of credit is in use, the issuing bank does not wait for the buyer to default, and for the seller to invoke the undertaking.

In contrast, a guarantee is a written contract stating that IN THE EVENT the primary party (the buyer) is unable or unwilling to pay its dues to the supplier the bank, as guarantor to the transaction the BG issuer would pay (the client's debt) to the supplier.

In other words, a bank guarantee is an undertaking of a bank on behalf of its customer. But this comes into play ONLY WHEN the principal party (the buyer) has failed to pay its supplier. (Do note this key point.)

Essentially, the bank becomes a co-signer for its customer's purchases.

Hence, in a BG the initial claim is still settled primarily (i.e., first) against the bank's client, and not the bank itself. Should the client default, ONLY THEN would the bank (which has issued the BG) agree to pay for it's client's debts on behalf of its client. This is a type of contingent guarantee.

A bank guarantee, therefore, is more risky for the merchant and less risky for the bank. But this is not the case with a letter of credit (LC).

With a bank guarantee, if a client defaults the bank assumes liability. With a letter of credit, liability rests solely with the issuing bank (this being the key difference and the key advantage in an LC) which then must collect the money from its client.

Therefore, the principal character of an LC is that it is a potential claim against the bank, rather than a bank's client. An LC substitutes the bank's credit for its client's. The seller's risk is mitigated from the risk that the buyer will not pay to the risk that the BANK will be unable to pay, which is unlikely.

A letter of credit is less risky for the merchant, but more risky for a bank, though banks accept full liability in both cases.

Quoting from [Catalyst]:



Bank Guarantees and LCs are financial instruments often used in inland or international trade when suppliers or vendors do not have established business relationships with their counterparts. The difference between the two instruments is the position of the bank relative to the buyer and seller of goods or services. The difference is as explained below.


A letter of credit is a bank’s DIRECT undertaking to the supplier (called the beneficiary) to pay. When a letter of credit is in use, the issuing bank does not wait for the buyer to default, and for the seller to invoke the undertaking.


In contrast, a guarantee is a written contract stating that IN THE EVENT the primary party (the buyer) is unable or unwilling to pay its dues to the supplier the bank, as guarantor to the transaction the BG issuer would pay (the client's debt) to the supplier.


In other words, a bank guarantee is an undertaking of a bank on behalf of its customer. But this comes into play ONLY WHEN the principal party (the buyer) has failed to pay its supplier. (Do note this key point.)


Essentially, the bank becomes a co-signer for its customer's purchases.


Hence, in a BG the initial claim is still settled primarily (i.e., first) against the bank's client, and not the bank itself. Should the client default, ONLY THEN would the bank (which has issued the BG) agree to pay for it's client's debts on behalf of its client. This is a type of contingent guarantee.


A bank guarantee, therefore, is more risky for the merchant and less risky for the bank. But this is not the case with a letter of credit (LC).


With a bank guarantee, if a client defaults the bank assumes liability. With a letter of credit, liability rests solely with the issuing bank (this being the key difference and the key advantage in an LC) which then must collect the money from its client.


Therefore, the principal character of an LC is that it is a potential claim against the bank, rather than a bank's client. An LC substitutes the bank's credit for its client's. The seller's risk is mitigated from the risk that the buyer will not pay to the risk that the BANK will be unable to pay, which is unlikely.


A letter of credit is less risky for the merchant, but more risky for a bank, though banks accept full liability in both cases.

Your definition of a Bank Guarantee is narrowly defined.  It is at least very common place to receive an Exporters BG covering the advance payment in the Red Clause of any D/C.  I know you deal in these things everyday but this has long been the practice in my business for any substantial red clause payment.  As we both know the red clause is the same as any direct T/T payment which is not supported by any documents.

Best regards,

Ranger

Replying to [Ranger]:

I have absolutely no disagreement with you on the point that you have made. A BG can be issued for several reasons - including an advance under a Red Clause Credit.

The points of my article were these:

(1) An LC is a *direct* responsibility of the issuing bank. The buyer does not at all come into the picture (his relation is with the issuing bank and no further). The LC is the primary instrument in a transaction.

(2) In contrast, a BG comes into operation (is invoked) *only when* the buyer has failed to perform his bit. The BG issuing bank is therefore the *second* line of defence, it is not the primary party.

Quoting from [Catalyst]:


Replying to [Ranger]:


I have absolutely no disagreement with you on the point that you have made. A BG can be issued for several reasons - including an advance under a Red Clause Credit.


The points of my article were these:


(1) An LC is a *direct* responsibility of the issuing bank. The buyer does not at all come into the picture (his relation is with the issuing bank and no further). The LC is the primary instrument in a transaction.


(2) In contrast, a BG comes into operation (is invoked) *only when* the buyer has failed to perform his bit. The BG issuing bank is therefore the *second* line of defence, it is not the primary party.

I understood what you were saying R.N.,   I just wanted to show readers that the BG could be used yet another way.  Thanks for you continued contributions and articles!!

Ranger

Replying to [Catalyst]:

Learning! Thank you!!

Replying to [lindy]:

Enquiries and puzzles welcomed.

Quoting from [Ranger]:

Quoting from [Catalyst]:




Bank Guarantees and LCs are financial instruments often used in inland or international trade when suppliers or vendors do not have established business relationships with their counterparts. The difference between the two instruments is the position of the bank relative to the buyer and seller of goods or services. The difference is as explained below.



A letter of credit is a bank’s DIRECT undertaking to the supplier (called the beneficiary) to pay. When a letter of credit is in use, the issuing bank does not wait for the buyer to default, and for the seller to invoke the undertaking.



In contrast, a guarantee is a written contract stating that IN THE EVENT the primary party (the buyer) is unable or unwilling to pay its dues to the supplier the bank, as guarantor to the transaction the BG issuer would pay (the client's debt) to the supplier.



In other words, a bank guarantee is an undertaking of a bank on behalf of its customer. But this comes into play ONLY WHEN the principal party (the buyer) has failed to pay its supplier. (Do note this key point.)



Essentially, the bank becomes a co-signer for its customer's purchases.



Hence, in a BG the initial claim is still settled primarily (i.e., first) against the bank's client, and not the bank itself. Should the client default, ONLY THEN would the bank (which has issued the BG) agree to pay for it's client's debts on behalf of its client. This is a type of contingent guarantee.



A bank guarantee, therefore, is more risky for the merchant and less risky for the bank. But this is not the case with a letter of credit (LC).



With a bank guarantee, if a client defaults the bank assumes liability. With a letter of credit, liability rests solely with the issuing bank (this being the key difference and the key advantage in an LC) which then must collect the money from its client.



Therefore, the principal character of an LC is that it is a potential claim against the bank, rather than a bank's client. An LC substitutes the bank's credit for its client's. The seller's risk is mitigated from the risk that the buyer will not pay to the risk that the BANK will be unable to pay, which is unlikely.



A letter of credit is less risky for the merchant, but more risky for a bank, though banks accept full liability in both cases.

Your definition of a Bank Guarantee is narrowly defined. It is at least very common place to receive an Exporters BG covering the advance payment in the Red Clause of any D/C. I know you deal in these things everyday but this has long been the practice in my business for any substantial red clause payment. As we both know the red clause is the same as any direct T/T payment which is not supported by any documents.

Best regards,

Ranger

Hello,

I am a first time user on this site....could you please explain what is Red Clause in D/C....please excuse me if i sound ignorant....but i am quite new to these terms...

thanks in advance

Quoting from [kavitabhat78]:

Quoting from [Ranger]:

Quoting from [Catalyst]:


Bank Guarantees and LCs are financial instruments often used in inland or international trade when suppliers or vendors do not have established business relationships with their counterparts. The difference between the two instruments is the position of the bank relative to the buyer and seller of goods or services. The difference is as explained below.

<deleted to save space>

Your definition of a Bank Guarantee is narrowly defined. It is at least very common place to receive an Exporters BG covering the advance payment in the Red Clause of any D/C. I know you deal in these things everyday but this has long been the practice in my business for any substantial red clause payment. As we both know the red clause is the same as any direct T/T payment which is not supported by any documents.

Best regards,

Ranger

Hello,


I am a first time user on this site....could you please explain what is Red Clause in D/C....please excuse me if i sound ignorant....but i am quite new to these terms...


thanks in advance

A Red Clause LC is one that authorises the advising bank to 'advance' a part of the face value of the LC to the beneficiary by way of pre-shipment finance. Since this clause used to be printed in red ink, it has come to be termed as Red Clause. The risk is entirely on the LC issuing bank (and hence, on the applicant).

Responding to Ranger: An 'exporter's BG' is also issued by a bank (being a bank guarantee, i.e.  BG) - his bank. The BG serves to protect the applicant (and his bank) against the possible failure of the exporter/beneficiary to eventually submit documents under the LC (from where the 'advance' is set off and reduced). Essentially, as pointed out in my article, the BG (unlike an LC) is a second line of defence. It comes into play IF the beneficiary fails to perform. In contrast, in LC operations, the first claim (and obligation) is against the LC issuing bank, not the party/beneficiary/applicant (as the case may be).

 

 

Quoting from [Catalyst]:

Responding to Ranger: An 'exporter's BG' is also issued by a bank (being a bank guarantee, i.e.  BG) - his bank. The BG serves to protect the applicant (and his bank) against the possible failure of the exporter/beneficiary to eventually submit documents under the LC (from where the 'advance' is set off and reduced).

Essentially, as pointed out in my article, the BG (unlike an LC) is a second line of defence. It comes into play IF the beneficiary fails to perform. In contrast, in LC operations, the first claim (and obligation) is against the LC issuing bank, not the party/beneficiary/applicant (as the case may be).

      May I say in other way ?

      Both are "give guaranty to pay",

      but  L.C is a must pay and BG is  If only .buyer not pay us.

      thank You.

     

Quoting from [Oneuni]:

Quoting from [Catalyst]:


Responding to Ranger: An 'exporter's BG' is also issued by a bank (being a bank guarantee, i.e.  BG) - his bank. The BG serves to protect the applicant (and his bank) against the possible failure of the exporter/beneficiary to eventually submit documents under the LC (from where the 'advance' is set off and reduced).


Essentially, as pointed out in my article, the BG (unlike an LC) is a second line of defence. It comes into play IF the beneficiary fails to perform. In contrast, in LC operations, the first claim (and obligation) is against the LC issuing bank, not the party/beneficiary/applicant (as the case may be).

      May I say in other way ?


      Both are "give guaranty to pay",


      but  L.C is a must pay and BG is  If only .buyer not pay us.


      thank You.


     

It would be a too simple definition, and not exactly correct either. Pl read my explanation once again. A guarantee and a direct undertaking/commitment are not the same. In an LC operation, though he is the actual buyer, the poor chap has absolutely no role to play. That is the beauty of an LC.   

Quoting from [Catalyst]:

Quoting from [Oneuni]:

Quoting from [Catalyst]:



Responding to Ranger: An 'exporter's BG' is also issued by a bank (being a bank guarantee, i.e.  BG) - his bank. The BG serves to protect the applicant (and his bank) against the possible failure of the exporter/beneficiary to eventually submit documents under the LC (from where the 'advance' is set off and reduced).

Essentially, as pointed out in my article, the BG (unlike an LC) is a second line of defence. It comes into play IF the beneficiary fails to perform. In contrast, in LC operations, the first claim (and obligation) is against the LC issuing bank, not the party/beneficiary/applicant (as the case may be).

      May I say in other way ?

      Both are "give guaranty to pay",

      but  L.C is a must pay and BG is  If only .buyer not pay us.

      thank You.

It would be a too simple definition, and not exactly correct either. Pl read my explanation once again. A guarantee and a direct undertaking/commitment are not the same. In an LC operation, though he is the actual buyer, the poor chap has absolutely no role to play. That is the beauty of an LC.   

      Carmelion /Camillon :  a  beauty  LZ = Lizard , mimicry and disguising in  phrase ...