Bank Guarantee vs Letter of Credit [The Difference]

If you’re conducting cross-border transactions or engaging in large construction projects, you might be comparing a bank guarantee vs letter of credit. If that’s the case, you’re in the right place…

In this article, we’re going to take a look at both the bank guarantee and a bank letter of credit so you can be better informed when approaching banks for either.

Additionally, we’ll touch on some of the challenges and other important considerations ranging from the difficulty in obtaining them and how LLC taxes for non-residents can impact your ability to unlock these financial instruments.

Feel free to use the table of contents to skip ahead to the topics most relevant to you:

Table of Contents

  1. What is the Difference Between a Letter of Credit and a Bank Guarantee?
  2. Bank Guarantee 101
  3. Letter of Credit 101
  4. Where Can You Get a Bank Guarantee or Letter of Credit?
  5. Ready to Explore Your Options?

What is the Difference Between a Letter of Credit and a Bank Guarantee?

Both a bank guarantee and a letter of credit are a commitment from a financial institution to fulfill commitments being made by one of their clients. With this in mind, both a bank guarantee and a letter of credit are credit products offered by banks.

That said, there are differences between the two credit options. However, the biggest difference that you’ll find when comparing a bank guarantee vs a letter of credit is their intended use.

In most cases, a bank guarantee is used in domestic transactions, particularly those related to large construction, real estate, and infrastructure projects.

On the other hand, a letter of credit is typically used by businesses engaged in cross-border trade, especially those involved in the import and export of physical goods.

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Bank Guarantee 101

As mentioned, a bank guarantee provides a financial commitment to parties that are engaging one of the bank’s clients in a transaction. In other words, the bank is guaranteeing that if their client is unable to meet the financial commitments outlined in the contract, the bank will pay it for them.

Not surprisingly, banks do not offer bank guarantees to everyone. Instead, they typically require the client to have an established relationship with the bank and will conduct detailed due diligence on the transaction and the parties involved.

Letter of Credit 101

Alternatively, letters of credit typically represent a smaller financial commitment from the bank. For example, instead of guaranteeing payment on a large multi-million dollar infrastructure payment, it’s possible for letters of credit to be issued for transactions in the thousands of dollars.

Again, while a letter of credit offers the same financial commitment from the bank, it is typically used to support international transactions between two parties. The most common example of this is when dealing with parties in multiple jurisdictions buying and selling goods that require a financial commitment before shipping.

Where Can You Get a Bank Guarantee or Letter of Credit?

Bank guarantees and letters of credit are common financial instruments around the globe. In fact, businesses in most countries can access either of these products, as long as they are able to qualify with local banks.

That said, it can be very difficult for international, non-resident, and foreign entities to obtain bank guarantees or letters of credit. This is especially true if the entity (or its owners) do not have an established relationship with the bank.

Additionally, it’s important to note that most banks will require credit history in the local jurisdiction where either the bank guarantee or letter of credit is being sought. With this in mind, non-resident entities such as non-resident-owned US LLCs will often struggle to obtain these products unless they have intentionally established a credit history and built bank relationships.

Ready to Explore Your Options?

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