Difference Between Standby Letter of Credit And Bank Guarantee
Is there any difference between Standby LC and Bank Guarantee? Let’s discuss. A standby LC and bank guarantee are quite similar products and most often, they are used in international transactions. There are many other similarities between these two products such as — similar purpose, or similar credit checks, etc, but they are different. How? Let’s find out:
What Is A Bank Guarantee?
A bank guarantee is a legal statement from a bank or lending institution that the liabilities of the debtors will be fulfilled and in the event, if the borrower defaults on a loan, it will be covered by the issuing bank. In simple words, it is the issuing bank that is responsible to meet the obligations of the borrower in case if he fails to make the payment. It means that the bank guarantee services take place when the borrower is at default.
What Is A Standby LC?
A standby letter of credit is a legal document issued by a bank or a particular financial institution guaranteeing a bank’s commitment towards on-time payment to the seller in the event if the buyer defaults on the agreement provided the seller fulfills the terms & conditions of the contract. It is a loan of last resort from the bank where the issuing bank stays in “ Standby Mode” and only interferes after being approached by the seller. This is the first and foremost difference between a bank guarantee and a Standby letter of credit services.
Standby Letter of Credit Vs Bank Guarantee
1. Scope of Usage — A Standby letter of credit significantly takes place in long-term contracts to provide payment security to the beneficiary as per the terms & conditions of the contract. Whereas, bank guarantee services are wider in scope comparatively as it is used in both long-term and short-term transactions. For example, real estate, construction projects, etc.
2. Scope of Protection — Although both of these trade finance instruments ensure that the seller gets paid on-time, there is a legal difference. Just like Standby LC, a bank guarantee protects the seller but at the same time, it also protects the buyer. While in the case of Standby LCs, only sellers are protected by the issuing bank.
3. Legal Difference — There is a big legal difference between a bank guarantee and a Standby LC. A bank guarantee is an obligation subject to civil law whereas a standby LC is subject to banking protocols.
4. Scope of Practicality — A BG is more practical than SBLC. The SBLC can be varied and is used for both financial and non-financial factors. The financial risk factors include on-time payment for the goods, whereas non-financial factors include the requirement of a particular material, or marginal defect, etc. While on the other hand, BG only covers financial performance such as the sale of goods, etc.
5. Type of Payment Covered — The SBLC is considered a secondary type of payment where the bank is only responsible to release the payment if the buyer defaults and the seller fulfills its terms in the contract. In simple words, if the buyer fails to make the payment and the seller meets the mentioned criteria, the issuing bank will make the payment.
Other Points Of Difference Between SBLC And BG
- Usage — A BG is used for both domestic and international transactions while SBLC is only used in international trade transactions.
- Bank Involvement — There is only a single bank involved in BG whereas SBLC involves a third-party bank also. It is usually a foreign bank.
- Types — There are many types of BG such as Payment Guarantee, or performance bond while SBLC has two main types which are — Financial standby LC and Performance standby LC
Bottom Line
It can be concluded that both bank guarantee and Standby LC share some similarities. Both are the legal documents from the bank to assure on-time payment to the seller in case if the buyer defaults. But there are some differences in terms of risk coverage and involvement. These two trade finance instruments are different from each other and the preference depends on the type of transaction taking place.
Originally published at https://www.emeriobanque.com.
