A letter of credit and buyer’s credit may sound similar but has completely different functions and characteristics from each other. There are different types of both of these credits for various purposes.
Letter of Credit vs Buyers Credit
The main difference between Letter of credit and the Buyers credit is that a letter of credit is available and can be used for any ordinary individual to one of the most significant business transactions. On the other hand, Buyers’ credit is mostly available for high-end purchases, or a massive import/export deal costing in millions of dollars.
A letter of credit is a piece of document that ensures the payment will be settled to the seller on behalf of the buyer. It is issued by a bank and is dated and timed to pay the full amount to the seller.
Buyers credit can be described as a credit facility for those people who are related to import and export business. The buyer will receive credits from an offshore bank of the country he is importing to pay off the exporter. The buyer is bound to pay that amount later with interest.
Comparison Table Between Letter of Credit and Buyers Credit (in Tabular Form)
| Parameter of Comparison | Letter of credit | Buyer’s credit |
|---|---|---|
| Cost | Banking institutions only charge their usual amount for issuing a letter of credit as it does not include any fund borrowing, hence no interest is being charged for it. | Buyer’s credit involves a tremendous amount of fund borrowing, and this is why banks charge a high rate of interest and processing fees as well. |
| Parties | In a letter of credit transaction, there are usually four parties involved, and they are – The buyer, buyer’s bank, the seller, and the seller’s bank. | In a buyer’s credit transaction, there are three parties involved, and they are – The buyer, buyer’s bank (domestic), Offshore bank that provides the credit facility. |
| Objective | The main objective/goal of a letter of credit is to become an intermediary or a payment instrument that can pay off any debt. | The main objective of a buyer’s credit is to provide a loan/credit facility that needs settling later with a higher rate of interest.. |
| Scope | In a letter of credit, the purchase and selling take place between the parties involved. Movement of the document and money is made. | In the buyer’s credit, only the transfer of funds is made between the parties. It is limited to funds only and has a lesser scope. |
| Obligation | The obligation falls on both the parties involved in a letter of credit. | The obligation falls on the importers in the buyer’s credit. |
What is Letter of Credit?
In simple words, a letter of credit guarantees payment to the seller on behalf of the buyer. It does not include any fund borrowing. In exchange for bank charges, they will issue you this document of any amount you want to be deducted from your account.
There are mainly three participants in a letter of credit process. The first one is the seller or beneficiary who will get paid. The next person is the buyer who will be paying. Then comes the letter of credit issuing bank. Besides, the beneficiary may apply for a bank of his own for accepting payment.
There are various types of letters of credit that are available that are being used widely in the market. Some of them are –
- First comes the sight credit. This document can be presented at the time of exchanging goods. The buyer could take all the products or funds right away using a sight credit.
- Time credit or acceptance credit is also a letter of credit which is commonly used by companies and businesses. This letter of credit means that even after buying the goods, you will have up to 30 days to pay the amount.
- When the beneficiary can transfer his letter of credit to any third party, it is called Transferable credit. These can be used to set off debts between the recipient and any other third parties.
- A letter of credit is safe and offers protection to both buyers and sellers.
A letter of credit is one of the safest payment methods for companies or business people. The bank will only issue a letter of credit upon applying if the company or business has enough assets/goods to cover the credit amount.
What is Buyers Credit?
A buyer’s credit can be explained as a credit availed for an importer through an offshore bank. This offshore account will provide you with a credit facility to complete to import deal and take back the amount with a rate of interest.
These credits are provided on a short term basis. A bank guarantee from the buyer’s country is needed to get this facility from an offshore bank.
There are a few advantages of buyer’s credit, and they are –
- The seller/exporter gets the payment on the due date or immediately at the time of exchange.
- The currency does not matter in this business or trading. In every country, you can use a buyer’s credit in their currency by providing enough documents.
- The importer/buyer can negotiate a better deal with the exporter regarding the immediate full payment.
The buyer’s credit is considered a short-term loan provided to an importer on a bank guarantee basis. The offshore bank that provides this credit facility will charge a bank charge and settle the full amount with a higher rate of interest.
Main Differences Between Letter of Credit and Buyers Credit
- A letter of credit can be provided, starting from an individual to a large business institution. The buyer’s credit is provided to import/export business people only.
- The cost of a letter of credit is significantly lesser than the cost of the buyer’s credit.
- The scope in a letter of credit is much more extensive than the buyer’s credit.
- The obligation falls on the importers in case of a buyer’s credit. Whereas, in a letter of credit, the liability will fall on both the parties.
- The bank charges a usual amount for issuing a letter of credit. In the case of the buyer’s credit, the bank will charge the usual amount and interest.
Conclusion
There are lots of differences between a letter of credit and a buyer’s credit. Both works on different platforms and yet fulfills almost the same purpose. Both of these payment instruments are safe enough to make any transaction. One is a little more expensive than the other one.
The buyer’s credit indicates immediate payment to the beneficiary, whereas a letter of credit gives a 30 day time to pay off the debt. The documents required for the approval of these two facilities are entirely different as well. The structure of both these credit facilities is altogether different and is very useful for business people.
References
- https://heinonline.org/hol-cgi-bin/get_pdf.cgi?handle=hein.journals/blj102§ion=22
- https://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=4400&context=uclrev
- https://www.nber.org/papers/w17146.pdf
- https://onlinelibrary.wiley.com/doi/abs/10.1111/1468-5957.00434