Trade Credit Insurance vs. Bank Guarantee (know the differences)

Trade credit insurance and bank guarantees are both instruments that are used in business. The scope of both these instruments is similar, although they do have their differences. In the span of this article, you will learn about what both of these instruments mean, as well as the features, benefits, and importance of each of the instruments.

Lastly, we will cement both concepts in your mind by giving you simple and easy to understand real world examples of the workings of both these instruments. Let’s initiate the topic!

• Meaning of Trade Credit Insurance
• Meaning of Bank Guarantee
• Trade Credit Insurance vs. Bank Guarantee
• Examples of both

Meaning of Trade Credit Insurance

A Trade credit insurance is a contract between the insured (generally a business) and the insurance company. The role of a trade credit insurance (TCI) policy is that it provides coverage to the policyholder in the event that the client of the policyholder (a business) does not fulfill its payment obligations. Any losses originating from this are covered by the insurance company. We will explain this concept further with an example.

Meaning of Bank Guarantee

A bank guarantee is a written promise made by a bank that, in the event that a client defaults on his payment, the bank will step in and make the payment on behalf of the client. This instrument is important where there is a trust deficit. It increases business transactions because businesses are much more likely to conduct business freely by leveraging bank guarantees.

Trade Credit Insurance vs Bank Guarantee

Examples of TCI and Bank Guarantee

• Example of TCI: Let us assume that a fictitious manufacturing company called ABC Ltd wants to distribute its products to a new distributor. ABC Ltd is not sure of the creditworthiness of this new distributor. To circumvent this issue, ABC Ltd purchases Trade Credit Insurance that covers itself in the event that the distributor fails to meet his payment obligations.
• Example of a Bank Guarantee: Let us assume that a fictitious company called XYZ Ltd is in the business of trading. XYZ Ltd wants to export ₹1 crore worth of garments from India to Spain. In this case, it is the first time it has dealt with this new importer, and due to this, there is a deficit in trust. To circumvent this issue, XYZ Ltd has requested that its importer furnish him with a bank guarantee that the importer will pay up.