Differences Between Letters of Credit and Bank Guarantees

Raising capital, importing goods, or signing a construction contract often comes down to one question: does the counterparty want a letter of credit or a guarantee. On paper they look similar: a bank commits to pay if certain events occur. In practice, they behave very differently in a dispute, during performance issues, or when a buyer simply refuses to pay.

Letters of Credit and Guarantees: Why the Difference Matters

Letters of credit are documentary instruments. The bank pays if the beneficiary presents compliant documents, regardless of arguments about the underlying contract. A guarantee is usually a promise to pay if the applicant fails to perform or defaults, often after a demand that meets the wording of the guarantee. One structure protects payment on a shipment or service milestone. The other protects against default or non performance.

For many export, import, and project sponsors, the real challenge is choosing the structure that matches the commercial risk they are trying to hedge, and then ensuring the wording follows market rules such as UCP600 for commercial letters of credit, ISP98 for standbys, or URDG758 for demand guarantees.

What a Letter of Credit Actually Does

Letters of credit support the movement of goods and services by turning trade documentation into a payment trigger. In a typical import letter of credit, the issuing bank undertakes to pay the exporter once it presents documents that match the terms of the credit: bills of lading, invoices, insurance certificates, inspection reports, and similar items.

What a Bank Guarantee Actually Does

A bank guarantee is a promise by the bank to pay the beneficiary if the applicant does not perform or does not pay. It is usually requested when a buyer or project owner wants comfort that the counterparty will honour its obligations under a supply, construction, lease, or service contract.

Key Differences Between Letters of Credit and Guarantees

Letters of credit and guarantees both shift risk from a commercial counterparty to a bank, but they do so in different ways. One focuses on documents and shipping or milestone events. The other focuses on failure to perform or failure to pay.

For a corporate treasurer, export manager, or project sponsor, the key questions are who needs protection, which events should trigger payment, which rules and law will apply, and how the structure will interact with bank lines, collateral, and covenants.

How Corporates Use Each Instrument

In real transactions, letters of credit and guarantees are not theoretical tools. They change how parties price, negotiate, and fund deals.

Risk, Collateral, and Pricing

On the bank side, letters of credit and guarantees both consume credit lines. The way they are priced and collateralised often depends on tenor, jurisdiction, and the applicant financial strength.

For corporates, the commercial impact is clear. These instruments can free up trade while tying up credit lines. Structuring them correctly reduces disputes, misunderstandings, and surprise calls.

Which Instrument Makes Sense for Your Deal

Choosing between a letter of credit and a guarantee is not about which product sounds stronger. It is about matching the instrument to the risk that keeps you awake at night.

As a buyer or project owner, you are usually worried about non performance. The plant is late, the contractor walks away, or the supplier does not ship after taking an advance payment. In that case, you tend to ask for performance guarantees, advance payment guarantees, and sometimes standby letters of credit that work like demand guarantees.

As a seller or contractor, you are usually worried about not getting paid after delivering. That is where commercial letters of credit or confirmed standbys in your favour are more relevant. They allow you to convert bank risk into cash flow, sometimes by discounting the instrument.

Where both sides are concerned about performance and payment, a contract may include both: guarantees in favour of the project owner and letters of credit in favour of key suppliers.

Where We Fit in This Picture

Our role is to help sponsors, exporters, and corporate buyers translate commercial risk into bankable structures. That starts with understanding whether a letter of credit, a standby, a demand guarantee, or a mix of instruments is the right answer for the deal in front of you.

We review term sheets, draft wording for bank discussion, and help you position the request so that relationship banks, credit insurers, or specialist trade finance lenders can support it. Where activities fall under banking or securities rules, work is carried out through regulated partners in the relevant jurisdictions.

For clients who already have offers from their banks, we can stress test the proposed structure against the underlying contract, supply chain, and funding model. The objective is simple: fewer surprises when documents are presented or when a claim is made.

We act as arranger and advisor through regulated partners. Where banking or securities activity requires registration, activity is carried out by or through appropriately licensed firms in the relevant jurisdictions. Nothing in this article is legal advice or an offer of financing. Any engagement is subject to KYC, AML, sanctions screening, and formal written agreements that define scope, territories, and fees. Parties should seek their own legal counsel on the enforceability of letters of credit, standby letters of credit, and guarantees under the chosen law and rules such as UCP600, ISP98, or URDG758.