A bank guarantee is a statement from a lending institute to ensure that the debtor can fulfill their liabilities. A Bank guarantee makes the bank liable to meet the person’s obligations if they fail to pay.
Whereas a Standby Letter of Credit (SBLC) is a type of guarantee made by a lending institution for the same purpose, i.e., to meet the debtor’s liabilities in case they fail to make the payment. The two terms have some differences and similarities, but they are not alike.
Both bank guarantee and standby letter of credit assure the creditor that they will receive the payment. These requests to the bank are treated as loans and are given based on the debtor’s credibility.
Key Takeaways
- A bank guarantee is a commitment by a bank to cover a specific financial obligation on behalf of its client in case the client fails to fulfill the obligation; an SBLC is a financial instrument issued by a bank, assuring payment to a beneficiary if the applicant fails to meet the agreed terms.
- Bank guarantees are used in various transactions, such as trade, construction, or loan agreements, to secure performance or payment obligations. In contrast, SBLCs are primarily used in international trade to ensure payment between parties.
- Both bank guarantees and SBLCs provide a financial safety net for the beneficiary. Still, a bank guarantee is a more direct commitment to a specific obligation. At the same time, an SBLC functions as a secondary form of payment if the applicant fails to meet the agreed terms.
Bank Guarantee vs. SBLC
A Bank Guarantee is a written undertaking by a bank to make payment to the beneficiary in the event that the applicant fails to fulfill its obligations. A Standby Letter of Credit (SBLC) is a similar financial instrument that functions as a guarantee of payment used to support a particular project.
Comparison Table
| Parameter of Comparison | Bank Guarantee | SBLC |
|---|---|---|
| Scope | Bank Guarantee has a broader range. | SBLC has a limited scope. |
| Duration | It is preferred in the case of both long-term and short-term contracts. | It is mainly used for long-term contracts. |
| Usage | It is used mainly for domestic and international transactions. | It is used in international trade transactions. |
| Protection | A single bank provides protection. | The issuing and third-party banks provide protection. |
| Insured | It has risk coverage for the buyer and the seller if the changes are requested. | It only covers the risk of the beneficiary, i.e., the insured. |
| Coverage | It covers only the financial aspect of the transaction. | It also covers the non-financial factors that affect performance. |
What is Bank Guarantee?
A bank guarantee is a statement from the bank to take over the liabilities of the insured in the event of failure to make payment. It is similar to a loan.
It is of two types – Direct and Indirect. Direct bank guarantees are used in the case of international transactions where the bank protects only the person to whom the warranty has been given. These are preferred in the case of international commerce as they are flexible and compatible with foreign norms.
An indirect bank guarantee is preferred by firms that are in exporting business. This is because it protects two banks, which is primarily foreign bank.
Bank guarantees enable firms to lower their financial risk and conduct transactions that might help them to expand their businesses. There are two types of bank guarantees – Financial warranties and Performance guarantees.
What is SBLC?
We first introduced SBLC. Standby Letter of Credit (SBLC/SLOC) is similar to a bank guarantee as it protects the buyer in case of default at the time of payment by covering their liability. It works on the principle of uberrimae fidei, which means utmost good faith.
SLBC costs 1% -10% of the value of the amount guaranteed per year. In SBLC, a bank only pays in the worst-case scenario because it is the lender of last resort. It is mainly used in long-term contacts.
It can be discounted like a letter of credit, and the seller can also get paid beforehand. It is a very flexible tool and is used widely in international transactions as it provides more security due to the involvement of two banks.
Similar to the bank guarantee, SBLC is also of two types, financial and performance. Financial SBLC focuses on ensuring that the payment is made.
Main Differences Between Bank Guarantee and SBLC
- A Bank guarantee protects both the buyer and seller, whereas SBLC only protects the beneficiary.
- Bank guarantee involves only a single bank, whereas SBLC involves a third-party bank, a foreign bank.
- Bank guarantee has a broad scope as it can be used for short-term and long-term transactions. SBLC is mainly preferred for long-term transactions.
- A Bank guarantee is used for domestic and international transactions, whereas SBLC is preferred for international transactions.
- A Bank guarantee only covers the financial aspect of the contract. SBLC covers both financial and non-financial aspects of the guarantee.
- https://bibliotecadigital.fgv.br/dspace/handle/10438/20172
- https://pdfs.semanticscholar.org/edb1/dcd00985ce0780578fec3b1106b6def02fad.pdf
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
