When it comes to satisfying payment obligations for international trade, there are a number of different ways you can ensure the proper payment for your goods or services – like a letter of credit, performance guarantee, bank guarantee or credit insurance.
Of these, credit insurance and bank guarantees are two of the most popular ways of guaranteeing payment. However, they differ quite a bit in how they work, their terms and conditions, and more.
In this article, Niche Trade Credit will look at the differences between credit insurance and a bank guarantee, and explain how they differ from one another.
Understanding A Bank Guarantee And How It Works
Essentially, a bank guarantee is a guarantee by a particular lending institution to cover the full amount of a loss in the event of a borrower defaulting on a loan. These guarantees are often used in international trade, as they help eliminate the risk of non-payment.
Because of the general nature of a bank guarantee, lenders can issue bank guarantees of many types. A few common types include:
- Payment guarantee – A payment guarantee ensures that a buyer will pay a seller on a particular date.
- Advance payment guarantee – This acts as collateral for the buyer, allowing them to recover advance payment from a buyer if the goods or services supplied do not meet the specifications outlined in the contract.
- Performance bond – A performance bond serves as collateral that will cover a buyer’s costs if the services or goods provided by a contractor do not meet its contractual requirements.
For example, in the event of a contractor failing to meet its contractual obligation to deliver steel of a particular grade, a performance bond would compensate the buyer for the loss incurred by the event.
Though there are many different types, they all have the same basic purpose – to protect companies from the risk of default or a failure to provide the specified goods and services and fulfill contractual obligations.
Understanding Credit Insurance And How It Works
Credit insurance is offered by an insurance company, and is much more simple and straightforward, compared to bank guarantees.
Credit insurance, also called “trade credit insurance,” is intended to protect providers of goods and services from nonpayment. For example, if you sell $1 million of items to a customer on net 30 terms and they fail to pay, your insurance policy will compensate you once the debt enters default.
Usually, unlike a bank guarantee, credit insurance policies do not compensate you for the full value of the owed money, but for a set percentage – usually 75-95% – of the invoice amount.
In most cases, credit insurance is the simplest and most affordable way to protect your accounts receivable against debt. Whether you’re working with customers who have high credit risks, extending credit to companies in foreign countries, or simply want to protect your cash flow from bad debt, credit insurance can be very useful.
Know The Difference Between Bank Guarantees And Trade Credit Insurance!
Depending on the type of trade you engage in and the goods and services you provide, either trade credit insurance or a bank guarantee may be right for you.
Need help deciding? Want more information about credit insurance? Contact Niche Trade Credit today. As a leading Australian insurance broker for more than 30 years, we can provide you with all of the information you need to make the right decision.
Get in touch today on 02 9416 0670.
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