Letter of Credit / Bank Guarantee

A Letter of Credit (LC) and a Bank Guarantee (BG) are financial instruments issued by banks to secure business transactions and reduce payment risks between buyers and sellers.
They serve as a trust mechanism, assuring one party that payment will be made or obligations will be fulfilled, even if the other party defaults.
These instruments are crucial for trade finance, government contracts, and international business transactions, providing financial security and credibility in business dealings.

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    Types of Letter of Credit / Bank Guarantee

    Letters of Credit and Bank Guarantees differ based on their structure, purpose, and conditions.
    Below are the most common types used in domestic and international trade:

    Sight Letter of Credit

    Payment is made immediately upon presentation and verification of required shipping or trade documents. Used in international trade for quick payment settlements.

    Usance / Term Letter of Credit

    Payment is made after a specific period (30, 60, or 90 days) from document presentation. Ideal for buyers seeking short-term credit or deferred payment.

    Revocable Letter of Credit

    Can be modified or cancelled by the issuing bank without prior consent of the beneficiary. Rarely used due to higher risk for exporters.

    Irrevocable Letter of Credit

    Cannot be altered or cancelled without consent from all parties (buyer, seller, and bank). This is the most common and secure form of LC in global trade.

    Confirmed Letter of Credit

    An additional guarantee is provided by a second bank (confirming bank), assuring the exporter of payment even if the buyer’s bank defaults.

    Standby Letter of Credit (SBLC)

    Acts as a safety net — payment is made only if the buyer fails to fulfill their financial obligations. Common in large projects, rentals, or service contracts.

    Why Is Letter of Credit / Bank Guarantee Important?

    Ensures Trust Between Parties

    Builds confidence between buyers, sellers, and banks in both domestic and international trade.

    Reduces Payment Risk

    Protects exporters from non-payment and importers from non-delivery.

    Facilitates Trade Finance

    Helps businesses engage in large-scale transactions and global trade without immediate cash flow issues.

    Enhances Business Credibility

    Demonstrates financial stability and builds trust with clients, suppliers, and government authorities.

    Supports Government and Infrastructure Contracts

    Required in tenders, EPC contracts, and public projects to assure performance and payment compliance.

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    FAQs

    What is a Letter of Credit (LC)?

    A Letter of Credit is a document issued by a bank guaranteeing that the seller will receive payment once the buyer meets all agreed conditions.

    A Bank Guarantee is a financial assurance from a bank that it will cover losses or obligations if the borrower or contractor fails to perform as agreed.

    • LC ensures payment for goods or services.
    • BG ensures performance or repayment of obligations. In an LC, the bank pays directly; in a BG, the bank pays only if the customer defaults.

    Any business entity, exporter, importer, or contractor engaged in trade, project work, or service contracts can apply through their bank.

    • Company KYC and business registration documents
    • Copy of trade contract or purchase order
    • Financial statements and bank records
    • Collateral (if required by the bank)

    Usually valid for 3 to 12 months, depending on contract duration or project timeline. Extensions can be requested through the issuing bank.

    Yes. MSMEs can avail LCs and BGs under government-backed trade finance schemes and through SIDBI or commercial banks.