Bank Guarantee (BG) vs Letter of Credit (LC) - Hindi - YouTube

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Namashkar, my name is Mukul and welcome to Asset Yogi

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In this video, we'll discuss about the difference between Bank Guarantee and Letter of Credit

Both are the non-fund based credit facilities that are given by a bank in trading finance

Many people get confused and understand the bank guarantee and letter of credit as the same type of instruments

But these are 2 different financial instruments

And are used in different situations

I made detailed videos on bank guarantee and letter of credit earlier

In those, I explained the concept of bank guarantee and letter of credit

I also made a separate video on types of letter of credit. So do watch those videos as well.

You'll understand the concepts in detail

In this quick video, we'll talk about the main differences between bank guarantee and letter of credit

And in which situations you should use bank guarantee and in which situations you should use letter of credit

So watch this video right from the beginning to the end. Let's switch on the blackboard

I already made detailed videos on bank guarantee and letter of credit

So if you haven't watched those videos yet, then do watch those first

So that you understand the concept clearly

Now let's do a quick recap about the working of the bank guarantee

So a buyer and a seller come to an agreement. It may be a trading agreement

Maybe the seller is selling something

Or it may be an agreement of a contractor or tendering agency

Maybe a government agency sign a contract

Let's say a contract of construction, real estate or infrastructure

Let's take an example

Let's say there is a road construction project worth Rs 100 Cr

So in this case, this is a tendering agency and this is a government department

So they'll ask how you'll complete a Rs 100 Cr project immediately

And we want a performance guarantee so that if we find any defect in your work

Then the performance guarantee will be forfeited and we'll do some recovery

So in this case, a bank comes in between and the guarantee is given through that bank

So the buyer/contractor request this bank guarantee from the bank

And the bank issue this bank guarantee to the seller or the tendering agency

So when the seller/government agency get the bank guarantee, the contract gets executed

So if there was an agreement for goods, then the seller sends the goods as they get the bank guarantee

So these goods can be some equipment worth Rs.1 crore

Let's say some computer equipment

So in this case, it may be goods or contract

So if they get the bank guarantee, the contract will be signed

This bank guarantee will be a performance bank guarantee

In the case of goods, the computer equipments will be transferred and will reach the buyer

So when the goods will be transferred or the contract will be signed

After that delivery is to be done to the buyer

So either they will do the payment or they will do the construction of the road

So what is the use of bank guarantee here?

Bank guarantee will only be used here when the buyer/contractor will default

So I am marking with a star

Bank guarantee is only encashed when a default takes place

If the buyer/contractor don't do the payment or delivery on time or don't do payment properly

Then only the bank guarantee will be encashed

But if we talk about the letter of credit, it is generally in the international trade

Where the buyer and seller don't know each other

So it is generally used in the relationship of importer and exporter

So the seller says that he will ship the goods only when they will give a letter of credit

How does letter of credit work?

The buyer will request for a letter of credit from the bank

That bank is called issuing or opening bank

Then the bank of the seller is the advising bank

The letter of credit reaches the advising bank

Then advising bank sends the letter of credit to the seller

All the details are there in that letter of credit like seller's name, product name, amount of that letter of credit

When the seller gets the letter of credit, it becomes cash equivalent

So the seller get to know that the buyer is very serious

After that, he ships the goods

As the goods are shipped, he gets the bill of lading which is the main document of the shipment

And this bill of lading goes to the advising bank

And then the advising bank do the payment

So the letter of credit is acting as a payment

So this is basically a cash equivalent and there's no default here

So transaction takes place with letter of credit

And this becomes a surety of 100% payment to the seller

But bank guarantee works only in case of default and it is a type of insurance

It is basically not a transaction but if any default takes place, then the bank guarantee is encashed

But in the case of a letter of credit, it is considered equivalent to cash and

the seller has surety that he'll get his money 100%

So because issuing and advising banks come in between and the advising bank do the payment on its credit risk

And later on, it recovers its payment from the issuing bank and issuing bank recovers from the buyer

So this whole process is detailed and I explained it in detail

So if you want to know in detail then do watch my letter of credit video

So if we want to summarise the differences and similarities between bank guarantee and letter of credit

So bank guarantee is a promise from the bank that if the buyer/seller doesn't meet their liabilities and default the agreement

In that case, the bank will pay the bank guarantee

So the bank will pay the payment to the seller according to the bank guarantee amount

But this is an obligation in the letter of credit that the bank has to pay the amount mentioned in it

So transaction becomes easier with this

So bank guarantee works as an insurance and it reduces to loss

Loss of the seller is reduced here.

If the buyer/contractor goes out of the business

Then only the bank guarantee amount will be recovered and there's no 100% recovery

But there's 100% payment through letter of credit. So the transaction takes place easily

And there's a surety

Where the bank guarantee is used generally?

It is used in trading and infrastructure contracts

Like real estate, road projects, telecom towers, power projects

So it is used in big projects and it is used in domestic and it is used in both domestic and international contracts

And the letter of credit is mainly used in international trades where buyer and seller don't know each other

So because of lack of trust, the transaction takes place through the letter of credit

So these are the main differences between a bank guarantee and a letter of credit

Now let's see the similarities

Both reduce the financial risks of buyer and seller

And banks check the credit worthiness of the buyer

before issuing any BG or LG, credit worthiness is seen

How are their relationships with the banks, do they repay their loans on time, fulfil the liabilities

Whatever credit they take, right!

And how is the financial standing, how strong is their balance sheet

Bank keep collateral be it FD or bank deposits

A bank guarantee or letter is issued only against a collateral

And bank charges a fee for bank guarantee or letter of credit

Both are non-fund based credit facilities but the work is totally different

Bank guarantee is encashed in case of default but the letter of credit

makes transactions easier and it is a type of cash equivalent

So the risk of the seller reduces and ships the goods on the basis of letter of credit

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