Bank Guarantees Vs. Credit Insurance – What’s the Difference?
Various mechanisms exist to help protect both exporters and importers from the risk of default, both in terms of payment and the supply of goods or services. Bank guarantees and credit insurance are two such commonly used mechanisms, particularly when letters of credit (LCs) are not used. While both provide similar protections, there are some important differences between the two.
As the name implies, a bank guarantee is a formal arrangement where a bank guarantees a particular payment; in the case of international trade, an exporter’s accounts receivable or an importer’s advances paid in lieu of goods receivable.
Bank guarantees come in various forms, with the most common for trade being:
Payment Guarantees – These guarantee that an exporter will receive payment from an importer on a specific date, without fail.
Advance Payment Guarantees – This kind of bank guarantee is used by importers to protect themselves against exporters defaulting on the supply of goods and or services, where advance payments have been made. Thus, in the event the exporter fails to supply goods and or services as specified in the contract, the importer can then use this instrument to recover the advance payment that they made.
Performance Bonds – A performance bond can go both ways. Thus, it can protect both exporters and importers in the event the other party fails to meet certain contractual obligations. For example, exporters can protect themselves from payment defaults and importers can protect themselves from the risk of exporters defaulting on the supply of goods and or services, as specified in the contract.
Trade credit insurance is issued by insurance companies to help exporters mitigate the risk of loss due to an importer defaulting on payments. This is an excellent tool, particularly for export businesses who wish to provide credit terms to new or less trusted buyers in order to remain competitive, while also protecting themselves from the risk of default.
With trade credit insurance, the moment the payment enters default, the insurer will make payment to the exporter. This form of insurance is also usually a simpler, more straight forward and easily accessible way for export businesses to protect their accounts receivable. One major way trade credit insurance differs from bank guarantees, however, is that insurance will usually not compensate for the full amount, commonly offering to cover only between 75% to 95% of the contract value.