International Capital Market Law

Question: Briefly explain the difference between a Commercial Letter of Credit, and a Demand Guarantee or Bank Guarantee, also known as a Standby Letter of Credit. Discuss briefly how each major variety of documentary credit is used in the market. Answer: Letter of credit: Letter of credit is a financial instrument, which is issued by the bank to the seller on the behalf of its customers. Thus, if buyers fail to make the payment so that bank will be liable to collect the purchase amount from the buyers. However, letter of credit often issued for international trade business (Sumangil, 2011). Bank guarantee: Bank guarantee is also a financial instrument, having almost similar function that of a letter of credit it means to ensure the liability of debtor will be met. Letter of credit and bank guarantee is the important financial instrument in the international market. Although, in a letter of credit, bank assures the seller that it will receive an amount to provide the goods and services to its buyers for a period of time. Hence, if the buyer fails to make the payment of goods and services so that bank will be liable to cover the cost of liability from the seller. But at the same time, bank guarantee agree to cover the liability (Onyiriuba, 2015). Thus bank contract between seller and buyer to cover debt amount, which is incurred by the buyer. Consequently, contract agreement reduces the financial risk in the market. However, letter of credit is a written document, which has some obligation for the fulfillment of the contract. Thus, the bank pays the total amount to the seller. On the other hand, in the bank guarantee, the seller receives the amount without any obligation as per in the contract. Moreover, letter of credit is mostly used in international business. Whereas bank guarantees are often used in real estates and infrastructure development, which overcomes the credit risk in the market (Todd, 2013). Simultaneously bank guarantee have a large market as compared to the letter of credit. Though, letter of credit issued by the lending institution i.e. import LCs, export LCs, revocable LCs, etc. whereas, bank guarantees comes in payment guarantee, loan guarantee, deferred payment guarantee, trade credit guarantee, etc. Furthermore, letter of credit issued subject to UCP600 that means UCP is the rules, which is prepared by the ICC banking commission. While bank guarantee issues the subject to U RDG758. However, in a letter of credit, the beneficiary receives the amount when he fulfills his duties (Parameswaran, 2011). At the same time, in bank guarantee, beneficiary claims its payment from the guarantor bank in case beneficiary fulfills his duties. Similarly, Letter of credit makes the transaction plain whereas bank guarantee mitigates the loss during failure of the transaction planned. Apart from this, merchants choose a letter of credit for effective delivery and payment system (Brooke and Buckley, 2016). But at the same time, in bank guarantee contractors proves their financial credibility due to effective bidding in infrastructure projects. Moreover, letter of credit is usually used for the international dealings that ensure the payment will be received. As well as, it reduces the nonpayment delivered goods risk in the market. Letter of credit helps to increase the business at international level. Similarly, seller easily calculates the payment date of goods with the help of a letter of credit. Whereas bank guarantee provides the protection to seller and buyer, repayment of advance payment deliveries is made on time, etc. (Onyiriuba, 2015). References Sumangil, C.A. (2011) Keys to Understand Documentary Letters of credit. UK: Lulu Press. Onyiriuba, L. (2015) Emerging Market Bank Lending and Credit Risk Control: Evolving Strategies to Mitigate Credit Risk, Optimize Lending Portfolios, and Check delinquent Loans. UK: Academic Press. Todd, P. (2013) Bills of Lading and Bankers' Documentary Credits. UK: Taylor Francis. Parameswaran, S. (2011) Fundamentals of Financial Instruments: An Introduction to Stocks, Bonds, Foreign Exchange, and Derivatives. USA: John Wiley Sons. Brooke, M.Z. and Buckley, P.J. (2016) Handbook of International Trade. UK: Springer.