Letters of credit or bank guarantees: a primer for importers

Importers in Kenya and East Africa often hear this from a new supplier: “We need bank security before we ship.” That can mean a letter of credit, a bank guarantee or a standby letter of credit, and each works differently.

Two instruments, two jobs

A letter of credit, or LC, is designed to be used. The seller ships, presents the documents the credit calls for, and the bank pays if they comply. A bank guarantee is designed not to be used: it pays out only if the applicant fails to do what it promised, such as paying on agreed terms.

Put simply: an LC is how you pay; a guarantee is what happens if you don't.

How a letter of credit works

Four parties are usually involved. You ask your bank, the issuing bank, to open the credit. It sends the credit to the seller's bank, which advises the seller and may add its confirmation. The seller ships and presents the documents the credit lists: typically a commercial invoice, a bill of lading or other transport document, a packing list, a certificate of origin and, depending on the terms of sale, an insurance document.

Banks deal in documents, not goods. If the documents match the credit, the bank pays, even if the cargo is disputed. If they don't match, payment can be delayed until the discrepancy is resolved or waived. Most LCs are issued subject to the ICC's Uniform Customs and Practice for Documentary Credits, known as UCP 600, which sets out how banks examine documents.

An LC can be payable at sight or later. Your bank sets a facility limit and usually asks for security.

How a bank guarantee works

A guarantee is a bank's promise to pay the beneficiary a stated amount if you fail to meet an obligation. For importers, the common type is a payment guarantee: it lets a supplier ship to you on open account because the bank stands behind your payment.

Guarantees appear elsewhere in trade too: customs bonds for goods in transit or bonded warehouses, advance-payment guarantees, and performance guarantees on supply contracts. Many are demand guarantees: the bank pays on a compliant written demand without investigating the underlying dispute. International ones are often issued under the ICC's Uniform Rules for Demand Guarantees, URDG 758.

A standby letter of credit sits between the two. It is drafted like an LC but used like a guarantee: it pays only if the applicant defaults.

Letter of credit

1. You apply to your bank.
2. Your bank issues the credit.
3. The seller's bank advises or confirms it.
4. The seller ships, presents documents and is paid if they comply.

Bank guarantee

1. You apply to your bank.
2. It issues the guarantee; the supplier ships on open account.
3. Only if you don't pay, the supplier makes a demand.
4. The bank pays, then recovers from you.

At a glance

	Letter of credit	Bank guarantee
Purpose	Pays the seller for the shipment	Protects the beneficiary if you default
The bank pays when	Compliant documents are presented	A valid demand is made under its terms
Typical use	New suppliers and first orders	Open-account terms, customs bonds, contracts
Watch for	Document discrepancies and tight dates	Open-ended wording and expiry dates

Which one fits?

• New supplier, first orders: an LC gives the supplier payment certainty and gives you documentary control over what was shipped.
• Established supplier on open account: a payment guarantee or standby LC can replace an LC, with less paperwork per shipment.
• Goods under customs control: a customs bond or guarantee may be required for transit or bonded storage.

What your bank will ask for

Banks treat LC and guarantee facilities as credit. Expect to provide financial and bank statements, your import history, supplier details and pro forma invoices, the purchase order and complete KYC documents. The bank will also ask how the goods are sold and how quickly cash comes back; a short note on your trade cycle answers that before it is asked.

Practical points for East Africa

Agree the Incoterm before the credit is drafted. Under CIF the seller arranges cargo insurance; under FOB it is usually your responsibility, and the documents the LC calls for should reflect that.

Allow realistic dates. A latest shipment date that is too tight, or a presentation period shorter than the voyage to Mombasa plus courier time, invites discrepancies. Plan for clearance too: duties, port charges and clearing costs fall due on arrival and belong in your cash plan.

Read guarantee wording closely: the amount, the expiry date and what the beneficiary must present to claim.

How we help

Epiidosis Africa advises importers on which instrument fits each trade, prepares the facility file and introduces you to independent licensed banks. Our risk consulting practice can review the cover on your cargo and contracts. Banks make the credit decisions and issue the instruments; we make sure your application is complete and credible.