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Bank guarantee (BG) vs letter of
credit (LC): What’s the difference?
Bank guarantee and letter of credit are two crucial documents for exporting from India. Learn more about the key differences between them in this blog.
Understanding financial tools such as a bank guarantee vs a letter of credit is crucial for Indian exporters navigating international trade. A single misstep in choosing between the two can lead to delayed payments, blocked shipments, or even loss of business. Despite their common use in global trade, many businesses confuse their purpose and risks.
This blog breaks down the differences between a letter of credit versus bank guarantee, their types, real-world use cases. The aim is to help Indian businesses decide how to choose between them, especially when trading with overseas buyers like those in the United States.
This blog breaks down the differences between a letter of credit versus bank guarantee, their types, real-world use cases. The aim is to help Indian businesses decide how to choose between them, especially when trading with overseas buyers like those in the United States.
What is a bank guarantee (BG)?
A bank guarantee is a promise from a bank that the liabilities of a debtor will be met in case the debtor fails to meet their contractual obligations. It serves as a safety net, assuring the beneficiary that the bank will cover any losses if the debtor cannot complete the transaction.1
Types of bank guarantees
Bank guarantees come in various forms, each tailored to specific situations in trade. Some of these are:
● Performance guarantee: This type of guarantee is crucial in contracts, where it serves as an assurance that the party involved will fulfill their performance obligations. If they fail to do so, the bank covers the losses.
● Advance payment guarantee: Often used in transactions involving upfront payments, this guarantee ensures the return of the advance payment if the supplier does not deliver the goods or services as agreed.
● Financial guarantee: This broader form of guarantee is used to ensure the payment of a specific financial amount, offering a safety net in financial transactions.
● Bid bond guarantee: Crucial in tender and bidding processes, a bid bond guarantee is a sign of the bidder’s commitment and capability to fulfill the contract if awarded.
● Foreign bank guarantee: These are guarantees used in international trade, where an Indian bank guarantees payment on behalf of a domestic client to an overseas beneficiary.
● Shipping guarantee: A document used in trade finance that allows importers to collect goods before the official shipping documents arrive.2
Need for bank guarantee in export
Bank guarantees are significant for the following reasons:
Mitigates risk:
Export transactions inherently carry risks due to distance, different legal systems, and potential communication barriers. A bank guarantee mitigates these risks by assuring the seller that they will be compensated if the buyer fails to fulfill their contractual obligations.
Enhances credibility:
A bank guarantee acts as evidence of credibility, which is especially valuable for exporters who are new to international markets or dealing with unknown buyers. It assures buyers that a reputable financial institution backs the exporter’s commitments.
Facilitates trade finance:
Many export transactions require substantial upfront investment for production and logistics. Bank guarantees ease the process of obtaining finances, as lenders are more willing to provide funds when risks are mitigated.
Ensures compliance with contractual obligations:
A bank guarantee is a mandatory requirement in many international contracts. It ensures compliance with contractual norms and signals professionalism and reliability.
Cushions against political and economic fluctuations:
Export markets are often vulnerable to political and economic changes. Bank guarantees provide a safety net against such uncertainties, ensuring that the exporter is safeguarded against unforeseen events that might affect the buyer’s ability to fulfill their obligations.3
What is letter of credit (LC)?
A letter of credit (LC) is a trade finance document issued by a buyer’s bank. It guarantees payment to the seller, provided the terms and conditions mentioned in the LC are met.
For Indian exporters, especially when dealing with unknown buyers or new markets like the US, LCs offers strong payment security by shifting the risk from the buyer to their bank. For example, an Indian textile exporter will get paid after submitting required documents, even if the buyer later faces financial issues.
For Indian exporters, especially when dealing with unknown buyers or new markets like the US, LCs offers strong payment security by shifting the risk from the buyer to their bank. For example, an Indian textile exporter will get paid after submitting required documents, even if the buyer later faces financial issues.
Types of letters of credit
Different trade scenarios call for different LCs. Understanding the right type can help you minimize risks and align with buyer expectations. Some of the different types of LCs are:
● Revocable LC: Can be modified or canceled by the buyer without notice. Rarely used due to high risk for exporters.
● Irrevocable LC: Cannot be changed without all parties’ consent. Most common and preferred for international trade.
● Confirmed LC: Includes an additional guarantee from the exporter’s bank, ensuring payment even if the buyer’s bank fails.
● Unconfirmed LC: Only involves the issuing bank’s commitment. Suitable when the exporter trusts the foreign bank.
● Transferable LC: Allows the original beneficiary to transfer part of or all the credit to another party. Useful for traders or intermediaries.
● Standby LC: Functions like a bank guarantee. Used if the buyer fails to meet obligations; the seller can draw funds.5
Letter of credit (LC) vs bank guarantee (BG): Key differences
In international trade, both LC and BG serve to instill trust. However, they operate differently based on who bears the risk and when the payment is made.
Before diving in, remember: LC is a payment guarantee, while BG is a performance safeguard.
Before diving in, remember: LC is a payment guarantee, while BG is a performance safeguard.
Factor
Letter of credit (LC)
Bank guarantee (BG)
Liability
Bank takes primary responsibility and pays the seller directly.
Bank pays only if the buyer defaults; responsibility is secondary.
Risk
Lower risk for seller as the bank ensures payment.
Higher risk for buyer and seller.
Usage
Used by exporters to secure payment from unfamiliar buyers.
Bank steps in only if buyer doesn’t pay.
Common Usage
Predominantly in international trade for goods.
Construction projects, tender bids, performance bonds.
Beneficiary
The seller/exporter of goods or services.
The buyer/importer or project owner.6
When to use a letter of credit vs bank guarantee
Understanding the context of the trade transaction helps determine the appropriate instrument.
For advance payments or high-value orders, Indian exporters might prefer a letter of credit. It ensures they receive payment upon fulfilling contract terms, irrespective of the buyer’s financial situation. This is especially important when dealing with buyers who require strict compliance.
In contrast, a bank guarantee is ideal when the exporter must commit to project performance, such as in construction, machinery installation, or government tenders. Here, the buyer needs assurance that the exporter will deliver as promised — or compensate otherwise.7
For advance payments or high-value orders, Indian exporters might prefer a letter of credit. It ensures they receive payment upon fulfilling contract terms, irrespective of the buyer’s financial situation. This is especially important when dealing with buyers who require strict compliance.
In contrast, a bank guarantee is ideal when the exporter must commit to project performance, such as in construction, machinery installation, or government tenders. Here, the buyer needs assurance that the exporter will deliver as promised — or compensate otherwise.7
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Registered sellers can choose to ship their products by themselves through Merchant Fulfilled Network (MFN) or they can opt for Fulfillment by Amazon (FBA) and outsource order fulfillment to Amazon including packing, storage, delivery, and returns. Amazon Global Selling simplifies the process of international shipping to the world, helping businesses navigate customs and reach a vast audience.
Frequently Asked Questions
1. Who is eligible for a bank guarantee?
Eligibility for a bank guarantee typically includes businesses, including corporations and sole proprietors, with good credit history and financial health.
2. What is the minimum period for a bank guarantee?
The minimum period of a bank guarantee varies depending on the agreement between the bank and the applicant. Generally, it could be:
● Short-term guarantees: As brief as a few months for specific, short-term contracts or transactions.
● Project-specific duration: Aligned with the timeline of a particular project or contract.
● Short-term guarantees: As brief as a few months for specific, short-term contracts or transactions.
● Project-specific duration: Aligned with the timeline of a particular project or contract.
3. What are the advantages of a bank guarantee?
The advantages of a bank guarantee include:
● Reducing the risk of financial loss due to non-fulfillment of contractual obligations.
● Boosting the business’s credibility and trustworthiness in the eyes of partners and clients.
● Improving financial flexibility of the business.
● Access to new opportunities.
● Beneficial in cross-border transactions where there is less familiarity and higher perceived risk.
● Reducing the risk of financial loss due to non-fulfillment of contractual obligations.
● Boosting the business’s credibility and trustworthiness in the eyes of partners and clients.
● Improving financial flexibility of the business.
● Access to new opportunities.
● Beneficial in cross-border transactions where there is less familiarity and higher perceived risk.
Published on April 8, 2024.
Updated on August 5, 2025.
Sources:
1. https://www.tradefinanceglobal.com/letters-of-credit/difference-between-lcs-and-bank-guarantees/
2. https://cleartax.in/s/bank-guarantee
3. https://www.eximguru.com/exim/guides/export-finance/ch_8_bank_guarantees.aspx
4. https://www.trade.gov/letter-credit
5. https://www.investopedia.com/ask/answers/110614/what-are-different-types-letters-credit.asp
6. https://www.businessgo.hsbc.com/en/article/bank-guarantee-vs-letter-of-credit-differences-and-how-to-choose
7. https://www.credlix.com/blogs/letters-of-credit-vs-bank-guarantees-essential-guide-for-importers-and-exporters
Updated on August 5, 2025.
Sources:
1. https://www.tradefinanceglobal.com/letters-of-credit/difference-between-lcs-and-bank-guarantees/
2. https://cleartax.in/s/bank-guarantee
3. https://www.eximguru.com/exim/guides/export-finance/ch_8_bank_guarantees.aspx
4. https://www.trade.gov/letter-credit
5. https://www.investopedia.com/ask/answers/110614/what-are-different-types-letters-credit.asp
6. https://www.businessgo.hsbc.com/en/article/bank-guarantee-vs-letter-of-credit-differences-and-how-to-choose
7. https://www.credlix.com/blogs/letters-of-credit-vs-bank-guarantees-essential-guide-for-importers-and-exporters
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*Map not to scale. The map has been used for design and representational purpose only, it does not depict the geographical boundaries of the country. These do not conform to the external boundaries of India recognized by the Survey of India.
*Map not to scale. The map has been used for design and representational purpose only, it does not depict the geographical boundaries of the country. These do not conform to the external boundaries of India recognized by the Survey of India.
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