The purpose of a letter of credit transaction is to make payment to the seller by the foreign buyer’s bank against the presentation of documents representing the goods. This means the seller must provide the documents required and hand them over to the foreign buyer’s bank. After receiving the documents, the bank will make payment of the contractual price agreed between the seller and the foreign buyer. The letter of credit is therefore a method of payment used in international trade that gives both parties confidence that the obligations stipulated in their commercial contract will be performed. The letter of credit transaction requires the participation of two banks: one from the foreign buyer’s country and the other from the seller’s country. These banks have important roles in the letter of credit transaction, as explained in the eLearning course Letter of Credit.

A bank guarantee, on the other hand, is not a method of payment in international trade, and it is the main difference between these two transactions. The demand for payment under the guarantee will be made only if one of the contractual parties is in breach of the commercial contract. For this reason, it could be argued that the primary purpose of the demand guarantee is securing the proper performance of the commercial contract, rather than making payment to the beneficiary.

See our eLearning course Demand Guarantees