A letter of credit and a buyer’s credit may sound similar but have different functions and characteristics. There are different types of both of these credits for various purposes.
Key Takeaways
- A letter of credit is a guarantee from a bank that ensures payment to a seller on behalf of a buyer, provided specific conditions are met.
- A buyer’s credit is a short-term loan facility provided by a bank or financial institution to an importer, enabling them to finance the purchase of goods or services from an overseas supplier.
- Both instruments facilitate international trade; however, a letter of credit primarily reduces transaction risk, while buyer’s credit provides financing for importers.
Letter of Credit vs Buyers Credit
The difference between a Letter of credit and a Buyers credit is that a letter of credit can be used for any ordinary individual for one of the most significant business transactions. On the other hand, Buyers’ credit is known primarily for high-end purchases or massive import/export deals costing millions of dollars.
A letter of credit is a document that ensures the payment will be settled to the seller on behalf of the buyer. It is issued by a bank and is dated and timed to pay the total amount to the seller.
Buyers’ credit can be described as a credit facility for those related to import and export business. The buyer will receive credits from an offshore bank of the country he is importing to pay off the exporter.
Comparison Table
| Parameter of Comparison | Letter of credit | Buyer’s credit |
|---|---|---|
| Cost | Banking institutions only charge their usual amount for issuing a letter of credit as it does not include any fund borrowing. Hence no interest is being charged. | Buyer’s credit involves a tremendous amount of fund borrowing, which is why banks charge a high rate of interest and processing fees. |
| Parties | In a letter of credit transaction, there are four parties involved, and they are – The buyer, the buyer’s bank, the seller, and the seller’s bank. | In a buyer’s credit transaction, there are three parties involved, and they are – The buyer, the buyer’s bank (domestic), Offshore bank that provides the credit facility. |
| Objective | The main objective/goal of a letter of credit is to become an intermediary or a payment instrument that can pay off any debt. | The main objective of a buyer’s credit is to provide a loan/credit facility that needs settling later with a higher interest rate. |
| Scope | In a letter of credit, the purchase and selling occur between the parties involved. Movement of the document and money is made. | Only the fund’s transfer is made between the parties in the buyer’s credit. It is limited to funds only and has a lesser scope. |
| Obligation | The obligation falls on both parties involved in a letter of credit. | The obligation falls on the importers in the buyer’s credit. |
What is Letter of Credit?
Simply put, a letter of credit guarantees payment to the seller on behalf of the buyer. It does not include any fund borrowing.
There are mainly three participants in a letter of the credit process. The first one is the seller or beneficiary who will get paid. The following person is the buyer, who will be paying.
Various types of letters of credit are available and being used widely in the market. Some of them are –
- First comes the sight credit. This document can be presented at the time of exchanging goods.
- Time credit or acceptance credit is also a letter of credit commonly used by companies and businesses.
A letter of credit is one of the safest payment methods for companies or business people. The bank will only issue a letter of credit upon applying if the company or business has enough assets/goods to cover the credit amount.
What is Buyers Credit?
A buyer’s credit can be explained as a credit availed for an importer through an offshore bank. This offshore account will provide you with a credit facility to complete to import deal and take back the amount with a rate of interest.
These credits are provided on a short-term basis. A bank guarantee from the buyer’s country is needed to get this facility from an offshore bank.
There are a few advantages of buyer’s credit, and they are –
- The seller/exporter gets the payment on the due date or immediately at the exchange time.
- The currency does not matter in this business or trading. You can use a buyer’s credit in their money in every country by providing enough documents.
The offshore bank that provides this credit facility will charge a bank charge and settle the total amount with a higher interest rate.
Main Differences Between Letter of Credit and Buyers Credit
- The obligation falls on the importers in case of a buyer’s credit. Whereas in a letter of credit, the liability will fall on both parties.
- The bank charges a usual amount for issuing a letter of credit. In the case of the buyer’s credit, the bank will charge the usual amount and interest.
- https://heinonline.org/hol-cgi-bin/get_pdf.cgi?handle=hein.journals/blj102§ion=22
- https://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=4400&context=uclrev
- https://www.nber.org/papers/w17146.pdf
- https://onlinelibrary.wiley.com/doi/abs/10.1111/1468-5957.00434
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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.
