Bank Guarantees and Letters of Credit: The Non-Fund Limits Most Companies Underuse
Most companies know their working capital limits, term loans, and overdraft facilities well. Fewer pay the same attention to non-fund based limits, mainly bank guarantees and letters of credit. These instruments do not put cash in your account. They put the bank’s name behind your promise, which is often worth more than cash when you are bidding for a project, importing raw material, or signing a long-term supply contract.
For mid-market developers and contractors in particular, non-fund limits decide whether you can even bid on a tender, not just how you fund the work once you win it. Here is what bank guarantees, letters of credit, and standby letters of credit actually do, how they differ, and when each one fits.
What Is a Bank Guarantee?
A bank guarantee is a bank’s promise to cover a loss if you fail to meet a contractual obligation. If you default on a payment, a project deadline, or any other term in the contract, the bank pays the other party up to the guaranteed amount, and then recovers that money from you.
The bank does not hand over funds unless you default. Until then, the guarantee sits in the background as a form of assurance to the party you are contracting with, whether that is a government body awarding a tender or a developer’s client wanting proof you can finish the job.
What Is a Letter of Credit?
A letter of credit is a bank’s commitment to pay a seller on behalf of a buyer, once the seller meets the conditions set out in the contract, usually delivering goods and presenting the right shipping documents, invoices, and inspection reports.
Unlike a bank guarantee, an LC is built to be used. Payment is expected to happen once the seller performs, not as a backup if something goes wrong. This is why letters of credit are the standard instrument in international trade: they replace trust between two parties who may never have dealt with each other before with the bank’s own creditworthiness.
What Is a Standby Letter of Credit (SBLC)?
A standby letter of credit works differently from a regular LC, even though it shares the name. It acts as a safety net rather than a payment mechanism. The bank only steps in and pays if the buyer fails to pay or perform as agreed.
In that sense, an SBLC behaves more like a bank guarantee than a standard LC, and is commonly used in:
- International trade, as a backup if the primary payment method fails
- High-value contracts, where a counterparty wants extra security
- Long-term supply agreements, spanning multiple deliveries or years
- Loan security or credit enhancement, backing a borrower’s obligations to a lender
Types of Bank Guarantees
Not every bank guarantee covers the same risk. Tap each one to see what it does.
Types of Letters of Credit
Letters of credit also come in several forms, depending on how and when payment is triggered.
Why Bank Guarantees Matter in Exports
Export contracts rarely run on trust alone, especially when the buyer and seller are on opposite sides of the world and have no prior relationship. Bank guarantees fill specific gaps that a letter of credit does not cover.
An advance payment guarantee protects an overseas buyer who pays upfront for goods, reimbursing them if the exporter fails to ship. A bid bond guarantee lets an Indian company compete for international tenders, where the tender issuer wants proof of seriousness before shortlisting bidders. A performance guarantee then backs the exporter’s commitment once the contract is awarded, assuring the foreign buyer that the order will be executed as agreed.
None of these replace the letter of credit that handles the actual payment flow. They sit alongside it, covering the risk that the exporter does not perform, which is a separate concern from whether the exporter gets paid.
Letter of Credit vs. Bank Guarantee: A Quick Comparison Table
| Aspect | Letter of Credit | Bank Guarantee |
|---|---|---|
| Primary purpose | Secures payment once the seller meets agreed terms | Covers losses if the applicant fails to perform |
| Payment trigger | Automatic, once documents and conditions are satisfied | Only on default by the applicant |
| Bank’s role | Primary payer | Backup payer |
| Risk for the beneficiary | Lower | Higher, since payment depends on proving default |
| Typical parties | Up to five: issuing bank, advising bank, confirming bank, buyer, seller | Usually three: bank, applicant, beneficiary |
| Common use | Cross-border trade, import and export payments | Construction, real estate, tenders, infrastructure and supply contracts |
| Indicative cost | Roughly 0.75% to 1.5% of transaction value | Roughly 0.5% to 1.5% of transaction value |
Primary purpose
Payment trigger
Bank’s role
Risk for the beneficiary
Typical parties
Common use
Indicative cost
How Leverest Gets a BG or LC Done
From a client’s first ask to the bank handing over the guarantee or credit, in eight steps. Hover or tap a step for a closer look.
When Should You Use BG, LC, or SBLC?
The right instrument depends on what you are trying to protect against, not just the size of the deal. Tell us what you are dealing with, and we will point you to the right one.
Conclusion
Bank guarantees, letters of credit, and standby letters of credit solve different problems. An LC gets goods paid for. A BG assures a counterparty that you will perform. An SBLC sits in reserve, activated only if something goes wrong. Treating them as interchangeable, or worse, not using them at all because they feel like paperwork rather than funding, means leaving bidding capacity and negotiating leverage on the table.
For companies bidding on tenders, signing multi-year supply contracts, or dealing with buyers and suppliers they do not yet fully trust, these non-fund limits are often the difference between being eligible to compete and being shut out before the negotiation even starts. Reviewing your current banking relationships for unused BG or LC limits is a reasonable place to start.