Executive Summary
- A Bank Guarantee assures a third party the bank will pay if your business defaults on an obligation
- A Letter of Credit assures payment to a seller once shipment or delivery conditions are met
- Both require a cash margin — typically 10–25% — that ties up working capital
- These facilities count against your overall credit exposure with the bank
What a Bank Guarantee Does
A Bank Guarantee is a commitment from your bank to pay a specified sum to a beneficiary if your business fails to fulfil a contractual obligation. Government departments and large corporates commonly require Performance Guarantees (ensuring contract completion) or Financial Guarantees (ensuring payment obligations) as a condition of awarding contracts to MSME suppliers, particularly in construction, supply, and services tenders.
What a Letter of Credit Does
A Letter of Credit serves the opposite direction — it assures a seller that payment will be made once they present documents proving they have shipped or delivered goods per agreed terms. For Karnataka MSMEs importing raw material or machinery, or selling to buyers who require LC-backed payment terms, this instrument removes payment risk from the transaction by substituting the bank's creditworthiness for the buyer's or seller's.
The Margin Requirement You Must Plan For
Both facilities require the borrower to maintain a cash margin with the bank — typically 10% to 25% of the guarantee or LC value, held as security. This margin ties up working capital for the duration of the guarantee or LC, which businesses bidding on multiple government tenders simultaneously often underestimate until several active guarantees collectively consume a meaningful portion of available liquidity.
Who Typically Needs These Facilities
Construction contractors and suppliers bidding on government or PSU tenders in Karnataka routinely need Bank Guarantee facilities as a standard tender requirement. Manufacturers importing machinery or raw material, or exporters dealing with overseas buyers requiring documented payment assurance, typically need LC facilities. If your business is expanding into either government contracting or international trade, securing a BG or LC facility alongside your existing working capital limit is worth planning for in advance rather than scrambling once a specific tender requires it.