Buyer’s Credit and Letter of Credit, both are utilised during cross border trade between two parties (importer & exporter). Though both seem similar term, but are completely different from each other and hence shouldn’t be misunderstood similar.
This article intends to distinguish between a letter of credit and a buyer’s credit based on every significant perspective.
Table of Contents
Buyer’s Credit vs Letter of Credit:
Before we rush into their distinctions, we need to learn what exactly are these terms in short.
A buyer’s credit refers to short-term finance available to importer/ buyer of goods or services from overseas lenders which could be foreign banks or other financial institutions.
A letter of credit, on the other hand, refers to the payment mechanism frequently utilised to facilitate international trades between two countries. The letter of credit (LC) not only ensures on-time payment to the supplier of goods but at the same time ensures shipment of goods as well.
Since there is always a credit risk of buyers while dealing cross border trade because of distance, different law in each country and different trading customs, hence, an LC mitigate such risk as the payment is guaranteed by the banks or financial institutions themselves.
Difference between Buyer’s Credit and Letter of Credit:
Now let us understand the difference between Buyer’s credit and letter of credit.
1) Meaning:
The most prominent difference lies in their meaning itself. A buyer’s credit is a short-term credit facility to finance the imports of goods and services, however, a letter of credit is a payment mechanism used in international trades.
2) Suitable For:
The buyer’s credit is utilised in high-value international transactions, whereas, letter of credit is suitable for all types of transactions.
Though in some cases, trade credit/ buyer’s credit is available only if the entire transaction/ trade is backed up with a letter of credit.
3) Cost involved:
Being a credit/ loan facility, the cost involved in buyer’s credit is interest cost and other managing charges. However, in the case of a letter of credit, the banks or financial institutions charge only processing fees.
4) Parties involved:
The main party involved in buyer’s credit are importer’s bank, buyer and foreign lenders which could be foreign banks, foreign branches of Indian banks or other financial institutions.
On the other hand, in case of letter of credit, there are minimum five parties involved as follows.
- Importer’s bank (Advisory bank)
- Buyer/ importer
- Supplier’s bank/ Negotiating bank
- Supplier/ exporter
- Confirming Bank
5) Obligation:
As buyer’s credit deals with credit availed to the importer of goods, hence if the importer fails to make payment on the due date, the entire liability for repayment of money pertains to the importer’s bank only.
However, in the letter of credit, both the parties (importer/ exporter) shall be responsible for any discrepancy as per the LC document. This is because an LC is an agreement for the entire transaction/ trade between exporter and importer.
6) Scope:
As we knew, a buyer’s credit is a credit facility, therefore, it is limited to the transaction of money only. On the other hand, a letter of credit has a broader scope as it guarantees payment as well as shipping of goods as per contractual agreement.
Buyer’s Credit vs Letter of Credit (Comparison table):
| Basis of Comparison | Buyer’s Credit | Letter of Credit |
|---|---|---|
| Meaning | It is a credit facility. | It is a payment Mechanism. |
| Suitable For | High-value trades | All types of trade |
| Costs | Interest is the major cost | Processing fees only. |
| Parties Involved | Importer, Importer’s bank, Overseas lender | Importer, Importer’s bank Exporter, Exporter’s bank Confirming bank |
| Obligation | Importer & importer’s bank | All parties are responsible for properly execution of the letter of credit’s terms & conditions |
| Scope | Narrow (Limited to funds) | Broader (Responsible for the entire trade b/w two parties) |
Conclusion:
In a nutshell, we can conclude this article as the buyer’s credit is a credit facility by the foreign lenders to the importer of goods whereas a letter of credit is a contractual agreement responsible to accomplish the entire cross-border trade between two countries (buyer & supplier).
However, there is one thing in common, both are utilised during international trade/ transaction. I hope this article would clear the confusion between Buyer’s Credit and Letter of Credit.
References:
Differnce between buyer’s credit and letter of credit :- eFinancemanagement (source)
