Bank Guarantee vs. Letter of Credit: What's the Difference?

A bank guarantee and a letter of credit are both promises from a financial institution that a borrower will be able to repay a debt to another party, no matter what the debtor's financial circumstances. While different, both bank guarantees and letters of credit assure the third party that if the borrowing party can't repay what it owes, the financial institution will step in on behalf of the borrower.

By providing financial backing for the borrowing party (often at the request of the other one), these promises serve to reduce risk factors, encouraging the transaction to proceed. But they work in slightly different ways and in different situations.

Letters of credit are especially important in international trade due to the distance involved, the potentially differing laws in the countries of the businesses involved, and the difficulty of the parties meeting in person. While letters of credit are primarily used in global transactions, bank guarantees are often used in real estate contracts and infrastructure projects.

KEY TAKEAWAYS:

A bank guarantee is a promise from a lending institution that ensures the bank will step up if a debtor can't cover a debt.

Letters of credit are also financial promises on behalf of one party in a transaction and are especially significant in international trade.

Bank guarantees are often used in real estate contracts and infrastructure projects, while letters of credit are primarily used in global transactions.


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