Difference Between Performance Bank Guarantee And Letter Of Credit
Being in an international business, you can understand the threat of several associated risks that you have to struggle with while dealing in overseas transactions. Apart from the risks of transportation, intellectual property, credit, and the difference in rules & law, other involved risks in the international trade are foreign exchange risk and political risk due to which it is sometimes difficult for the traders to maintain or grow their revenue. To mitigate these associated risks with international trade, various banks, and financial institutions are providing a range of trade finance instruments that enable firms to generate revenue growth and secure higher profits.
Some of these instruments include letters of credit, or bank guarantees, and many more. In this blog, we will discuss what a performance bank guarantee is and how it is different from letters of credit.
What Is A Performance Bank Guarantee?
Let’s first understand what a bank guarantee is. A bank guarantee is a legal commitment made by a bank or a financial institution to the beneficiary ie. sellers on behalf of the applicant ie. buyer for the assurance of payment or fulfillment of the terms & conditions in the event if the buyer is unable to do so. Now, what is a performance bank guarantee?
- A performance bank guarantee is a legal promise made by the bank to the buyer for the performance of the contract or an obligation.
- In simple words, if the seller is unable to perform or does not meet the requirements of the contract, the issuing bank will step-up and compensate a pre-decided amount to the buyer.
- In short, the buyer’s loss will be covered up by the bank in the event of non-performance or short performance of a contract on the hand of the seller.
- These types of bank guarantee services can be availed by businesses as well as individuals around the world.
- It acts as a bridge between the buyers and sellers of a contract focused on establishing a trustworthy relationship between these two parties involved in a transaction.
What Are The Advantages Of Performance Bank Guarantee Services?
In most of the cases where a performance BG is irrevocable, it provides various benefits to the buyer such as:
- It reduces the performance risks for the buyer.
- The buyers are assured of getting payment on-time in case of non-performance by the seller.
- If the buyer has initiated an advance amount to the seller for the ordered goods & services but does not find them as per the schedule, he can approach the bank and will be paid the money back.
How Performance Bank Guarantee Differs From Letters Of Credit?
Many individuals get confused between the letters of credit and performance bank guarantee. Here are the key differences between them. Let’s have a look:
- The primary difference between a performance bank guarantee and a letter of credit is that the letters of credit are issued to secure the benefits of the exporters in case if the importers default to make the payment or fulfill the requirements. While a performance bank guarantee protects the buyer in the event if the seller defaults.
- Secondly, a letter of credit acts as proof of creditworthiness of the buyer to the seller while a performance bank guarantee is particularly designed for the buyer and cannot be treated as proof of credit quality.
To conclude, we can say that both performance bank guarantees and letters of credit are important trade finance instruments that are widely used in global trade transactions. Though they are different from each other, they both have an essential role in reducing the risks for importers and exporters.
