Quick answer
A letter of credit is a bank's promise to pay a seller once agreed documents are presented. A bank guarantee is a bank's promise to pay a third party if you fail to meet an obligation. Both give comfort to the other side of a deal. Ownright Custom Finance can look at what is available and at alternatives where a bank will not issue one.
Key points
- A letter of credit assures a seller they will be paid if documents are in order
- A bank guarantee assures a third party if you fail to perform
- Banks usually want security or a cash deposit behind them
- Alternatives exist when a bank declines, such as other security structures
- Suits
- Importers, exporters, contractors, commercial tenants, suppliers
- Security
- Cash deposit, property, business assets or other lender-accepted security
- Purpose
- Give the other party comfort that they will be paid or protected
- Australia-wide
- Yes
What are letters of credit and bank guarantees?
Both are ways of putting a bank’s credibility behind your promise.
A letter of credit is a bank’s undertaking, issued at a buyer’s request, to pay a seller when the seller presents documents that match the agreed terms. Typical documents are the commercial invoice, transport papers and insurance. The seller does not have to trust the buyer, only that the documents are right and the bank is sound.
A bank guarantee is a bank’s promise to pay a third party, called the beneficiary, up to a stated amount if you do not meet a particular obligation. It is a back-up promise. If you perform, it is never called on.
Who needs these instruments?
- Importers whose overseas suppliers will not ship without payment assurance
- Exporters who want a buyer’s payment backed by a bank
- Contractors and builders who must provide performance security for a contract
- Commercial tenants whose landlord wants a guarantee instead of a cash bond
- Suppliers asked to give a payment guarantee for trade credit
- Businesses bidding for tenders that call for a bid or performance guarantee
If a counterparty has asked you for one of these, the request is usually about trust: they want comfort before taking a risk.
Letter of credit versus bank guarantee
| Letter of credit | Bank guarantee | |
|---|---|---|
| Main purpose | Payment for goods or services on presentation of documents | Protection if you fail to meet an obligation |
| Typical users | Importers and exporters | Contractors, tenants, suppliers, tender bidders |
| When the bank pays | When compliant documents are presented | When the beneficiary makes a valid claim |
| Usual security | Deposit, property or business assets | Deposit, property or business assets |
| Related reading | Trade finance | Secured business loans |
International letters of credit commonly follow rules published by the International Chamber of Commerce, though the details are set out in each instrument. Your accountant or lawyer can advise on the terms of a particular contract. Official trade bodies such as Austrade and Export Finance Australia publish practical material on payment terms in export deals.
What do banks look at before issuing one?
Banks treat these instruments as credit exposure. They ask:
- Your financial strength. Trading history, financial statements, BAS and bank statements
- The transaction. The amount, the counterparty and the purpose
- Security. Often a cash deposit or property security. See our guide to types of loan security
- Your existing facilities. Debts and security already in place
- The term. How long the instrument will remain open
If a bank asks for more security than you have available, or declines altogether, that is where options beyond a single bank matter.
How does Ownright approach this?
Ownright Custom Finance is a broker built around solutions. Trevor Scott has more than 40 years in finance, and the team works across trade, business, commercial and private lending. We do not issue letters of credit or bank guarantees ourselves. What we can do is look at what is available for your situation and at the ways of providing the security behind one.
If a bank wants more security than your business can offer, equity in a property might help: a secured business loan or a second mortgage could free up cash to lodge as a deposit. If the beneficiary will accept an alternative form of security, we can say what we know of the options. We work Australia-wide and we never promise outcomes, since results depend on the lender, the security and how quickly documents arrive.
An illustration
Illustrative scenario only. A building subcontractor wins a contract that requires a performance guarantee. The bank will issue one only against a cash deposit the business does not have available, because its cash is tied up in work in progress. The owner has equity in a property. We discuss whether that equity could be used to release funds for the deposit or to support a facility, what it would cost in terms of structure, and what the alternatives are. The contractor then decides with a clear picture rather than a rushed yes.
Mistakes to avoid
- Accepting wording without reading it. The text of a guarantee or credit determines when it can be claimed.
- Underestimating the security needed. Ask early what the bank will want behind it.
- Missing the deadline. Tender and contract dates are rarely flexible, so start well ahead.
- Letting the instrument expire without a plan. If it is called or extended, you need cash or an agreed renewal.
- Treating it as free. Fees and tied-up security have a cost.
What should I have ready?
- Details of the contract, tender or trade deal, including the beneficiary and amount
- Recent business bank statements, BAS and financial statements
- A schedule of existing debts and security
- Details of any cash, property or assets that could be offered as security
Our guide on what documents you need for a loan is a useful checklist.
Where do these fit with other finance?
Letters of credit often accompany import finance or export finance. Guarantees for supplier credit relate to supplier payment finance. If you need to release equity quickly, see how a short-term property loan works.
What are the alternatives if a bank will not issue one?
Sometimes the problem is not you but the bank’s appetite for the exposure or the security it wants. A few paths may be worth exploring.
One is to ask the beneficiary what they will accept. Landlords, principals and suppliers sometimes accept a cash bond, a different form of security or a guarantee from a non-bank provider. It costs nothing to ask.
Another is to change the security behind the facility. If you own property with equity, that equity may support a secured business facility, or release funds you can lodge as a deposit. Different lenders value property and business assets differently, so a decline from one is not the end of the road.
A third is to restructure the deal itself. Staged payments, smaller guarantee amounts or shorter guarantee terms can reduce the exposure a bank must take on, and may make approval easier.
Whichever route you choose, think about what happens if the guarantee is called. The money has to come from somewhere, quickly. Having a plan for that, even if you never use it, shows lenders and beneficiaries that you take the obligation seriously.
Need credit support for your next deal?
Sounds like you’re looking for help with letters of credit or bank guarantees. We’re the lending experts in finding ways to provide the security and funding behind them, so click the button below and see if you qualify.
How it works, step by step
- 1
Step 1
Tell us what the guarantee or letter of credit is for and who needs it.
- 2
Step 2
We check how it would normally be issued and what security is usually asked for.
- 3
Step 3
We look at lenders and structures, including alternatives if a bank will not issue it.
- 4
Step 4
Documents are arranged so the beneficiary has what they need by the deadline.
Frequently asked questions
What is a letter of credit?
A letter of credit is a promise from a bank, on a buyer's behalf, to pay a seller once the seller presents documents that match the agreed terms, such as shipping papers. It reduces payment risk for the seller, especially in overseas trade where the parties may not know each other well.
What is a bank guarantee used for?
A bank guarantee gives a third party comfort that money will be paid if you fail to meet an obligation. Common uses include rental bonds on commercial leases, contract performance, tenders and supplier credit. It is a contingent promise, so it is not a loan until it is called on.
Why do banks ask for security for a guarantee?
Because if the guarantee is called, the bank pays and then looks to you for repayment. To manage that risk, banks often ask for a cash deposit, property security or other assets behind the guarantee. How much depends on the bank, the amount and your financial strength.
What if my bank will not issue a guarantee?
There may be other routes. Some beneficiaries accept alternatives such as a cash bond or insurance-style bond, and other lenders may structure security differently. Property equity can also support a facility. We look at the options without promising a result, because the answer depends on your situation and the beneficiary.
Are letters of credit only for international trade?
They are most common in overseas trade, but the concept can apply to large domestic deals too. Whether one is appropriate depends on the contract, the parties and the amounts. Your accountant or lawyer can advise on the contract terms, and we focus on how the credit support is funded.