Credit insurance and bank guarantees are both financial tools for satisfying payment obligations for international trade. Typically, they are promises from a lending institution that a debtor will settle their debt to a third party, regardless of the borrower’s financial circumstances. These financial promises assure the third party that if the borrower fails to repay the owed money, the lending firm will pay the total value on behalf of the borrowing party.
Credit insurance and bank guarantees reduce potential risk factors, promoting seamless payment for goods and services. But there are some differences between these two tools concerning their terms and conditions and how they work. Below, financial gurus from Niche Trade Credit explain how these tools differ from one another.
What is Credit Insurance – How does it Work?
Credit insurance, sometimes called trade or business credit insurance, is a risk management policy often provided by an independent insurance company. They are commonly used by importing and exporting companies and allow businesses to safeguard themselves from non-payment. Credit insurance serves as a protection from an insurance provider.
If you sell goods or services and a customer defaults payment, your insurance coverage will compensate you for the loss suffered. However, unlike a bank guarantee which pays the total value, trade credit insurance will reimburse a certain percentage, usually 75 to 95 per cent.
Credit insurance is considered a cost-effective solution for shielding your accounts receivable from bad debt. This financial instrument is useful for businesses dealing with customers with high credit risks, looking to protect their cash flow from debt, or extending credit to companies outside their operation area.
What is a Bank Guarantee – How does It Work?
Bank guarantees are usually used in construction contracts and real estate infrastructure projects. The main difference between a bank guarantee and credit insurance is that a bank guarantee provides a more outstanding contractual obligation for banks.
A lending institution is a guarantor between the seller and the buyer in international trade. The institution insures both parties from damage or loss suffered due to defaulting of either party and will pay the total value of a loss.
Bank guarantees often take various forms, including the following:
- Loan guarantee – A lending firm that offers the loan ensures that the borrowing party pays the money. Failure to which, the institution takes the financial obligation.
- Confirmed payment guarantees – Requires the bank to pay a certain amount to a buyer on behalf of the seller by a specified date. This acts as an irrevocable obligation.
- Performance bonds – Performance bonds act as surety bonds to protect the buyer’s costs if the goods or services delivered by a contractor do not fulfill the contractual requirements.
- Advance payment bonds – These comprise collaterals that back up an agreement’s performance. It reimburses advance payments to protect the buyer should the seller fail to supply the items specified in the contract.
Although credit insurance and bank guarantees have some differences, they are both great financial equipment for fulfilling financial obligations in international trade.
How Niche Trade Credit Can Help
If you need help deciding which financial solution is good for your situation, experts from Niche Trade Credit can help. Schedule a free credit risk assessment to get started and learn how credit insurance solutions can help shield you and your business from bad debt.
Get in touch today on 02 9416 0670.
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