What is the Difference Between LC and Bank Guarantee?

A Letter of Credit (LC) and a Bank Guarantee are both financial instruments that provide a guarantee on behalf of a party in a transaction, but they serve different purposes and are used in different situations. Here are the main differences between the two:

1. Purpose: A Letter of Credit is primarily used in international trade, allowing two parties to transact without worrying about the other party's creditworthiness. A Bank Guarantee, on the other hand, is often used in real estate contracts and infrastructure projects, guaranteeing a buyer's or seller's performance.
2. Involved Parties: A Letter of Credit involves the buyer, seller, and their respective banks, while a Bank Guarantee involves the buyer, seller, and the buyer's bank.
3. Risk: A Bank Guarantee offers more value than a Letter of Credit, as it protects both parties in a contractual agreement from credit risk. In contrast, a Letter of Credit carries a higher risk for the bank but a lower risk for the merchant.
4. Liability: With a Bank Guarantee, the seller's claim goes first to the buyer, and if the buyer defaults, then the claim goes to the bank. With a Letter of Credit, the seller's claim goes first to the bank, not the buyer.
5. Usage: Bank Guarantees are commonly used when a contract has to be completed, and it only applies to a certain monetary amount and lasts for a set period of time. Letters of Credit are essential in international trade and are used to ensure that sellers receive payment, even if the buyer defaults.

In summary, a Letter of Credit is primarily used in international trade to ensure payment for sellers, while a Bank Guarantee is used in real estate and infrastructure projects to guarantee a party's performance. Both instruments reduce risk factors and encourage transactions, but they serve different purposes and involve different parties.

Comparative Table: LC vs Bank Guarantee

Here is a table highlighting the differences between a Letter of Credit (LC) and a Bank Guarantee:

In summary, a Letter of Credit ensures that a transaction proceeds as planned, while a Bank Guarantee provides an assurance that the bank will make the payment if the client defaults. The number of parties involved, risk, liability, types, and uses of these financial instruments differ as shown in the table above.