BG and LC refer to Bank Guarantees and Letters of Credit, respectively, both serving as financial instruments that provide security in transactions.
Here's a breakdown:
Bank Guarantee (BG)
A bank guarantee is a commitment from a lending institution to cover a debt if the debtor defaults. Think of it as an assurance that a payment will be made. According to the provided reference, a bank guarantee ensures the bank will step up if a debtor can't cover a debt.
Key Features of a Bank Guarantee:
- Security: It offers security to the beneficiary (the party receiving the guarantee).
- Obligation: The bank assumes the obligation to pay if the applicant (the party obtaining the guarantee) fails to fulfill their contractual obligations.
- Common Use: Frequently used in construction, supply contracts, and other business agreements where performance needs to be guaranteed.
Letter of Credit (LC)
A letter of credit is a financial document issued by a bank on behalf of a buyer, assuring the seller that payment will be made upon presentation of the required documents. The provided reference notes that letters of credit are also financial promises on behalf of one party in a transaction and are especially significant in international trade.
Key Features of a Letter of Credit:
- Payment Assurance: It provides assurance to the seller that they will receive payment.
- International Trade: Extremely important in international trade to mitigate risks associated with cross-border transactions.
- Documentary Compliance: Payment is contingent upon the seller providing documentation that complies with the terms of the LC.
- Example: Imagine a US company importing goods from China. The US company's bank can issue a letter of credit guaranteeing payment to the Chinese supplier once the goods are shipped and the proper documentation is presented.
BG vs. LC: Key Differences
While both provide financial security, they serve slightly different purposes. A Bank Guarantee is typically used as a performance guarantee, whereas a Letter of Credit is used for payment assurance, especially in international trade.
| Feature | Bank Guarantee (BG) | Letter of Credit (LC) |
|---|---|---|
| Primary Use | Performance Guarantee | Payment Assurance |
| Common Context | Construction, supply contracts, domestic business agreements | International trade, import/export |
| Trigger | Debtor default on obligations | Presentation of compliant documents |
