A credit guarantee is a form of insurance that helps to protect the interests of a seller from the chance of non-payment by a buyer. This type of coverage is often utilized when goods are imported, affording the exporter a degree of protection that would be difficult to achieve otherwise. In some cases, this type of guarantee is extended through a governmental organization. At other times, the credit guarantee is made available through banks that manage import and export transactions.
The exact structure of a credit guarantee depends on the governmental regulations that govern the transaction. In a situation where both the buyer and the seller are located in the same nation, it is not unusual for this type of coverage to be issued in what is known as a letter of guarantee. This is simply a legal document that affirms that if the buyer fails to tender the agreed-upon compensation for a purchase, that the insurer will honor the debt. A letter of guarantee may be in the form of a personal guarantee provided by an interested third party, or by a financial entity that has extended a line of credit to the buyer.
When the credit guarantee involves the import of goods, the purpose of the document is to provide the exporter with assurance of being compensated in the event that the importer defaults on the payment for the shipment. Often, the document is prepared by an export promotion agency in the country where the exporter resides. The amount of the guarantee usually depends on the agency’s assessment of the creditworthiness of the buyer, and the risk of shipping goods to the country where the buyer resides. There is also the possibility of obtaining this type of guarantee from an import export bank, a strategy that can sometimes provide the additional benefit of providing the exporter with a discount on any other bank services the seller wishes to obtain through the same financial institution.
While the focus of a credit guarantee is to protect the interests of the seller or exporter, the terms are also in the best interests of the buyer. For example, in the event that political unrest leads to an inability of the buyer to remit payment, the insurance coverage ensures the seller does not have to wait for compensation. From this perspective, the guarantee makes it possible for the business relationship to be placed on hold during the unrest, and keeps the possibility of doing business once again after the political crisis has passed.