Bank Guarantee Definition
A bank guarantee is a type of guarantee from a SBLC providers or lending institution. The bank guarantee means a lending institution ensures that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it. A bank guarantee enables the customer, or debtor, to acquire goods, buy equipment or draw down a loan. Bank Guarantee is an agreement between 3 parties viz. the bank, the beneficiary, and the applicant. The beneficiary is the one to who takes the guarantee. And the applicant is the party who seeks the bank guarantee from the bank. Bank Guarantee are an important banking arrangement and play a vital role in promoting international and domestic trade.
The bank issues Bank Guarantee on the receipt of the request from the applicant. This receipt is of the “guarantee amount” towards some purpose / underlying transaction towards the “beneficiary”. If the bank i.e. “the guarantor” receives the “claim” from the beneficiary, it results in “Bank Guarantee invocation”. In the case of foreign Bank Guarantee, apart from these 3 parties, there is also a “correspondent bank”. If a bank does not have a branch in some foreign country, it issues Bank Guarantee in that country through its “correspondent bank”. The bank does all the required due diligence, financial and business analysis before issuing the guarantee.
What You Need To Know About Bank Guarantee
A bank guarantee is when a lending institution promises to cover a loss if a borrower defaults on a loan. The guarantee lets a company buy what it otherwise could not, helping business growth and promoting entrepreneurial activity.
There are different kinds of bank guarantees, including direct and indirect guarantees. Banks typically use direct guarantees in foreign or domestic business, issued directly to the beneficiary. Direct guarantees apply when the bank’s security does not rely on the existence, validity and enforce ability of the main obligation. Individuals often choose direct guarantees for international and cross-border transactions, which can be more easily adapted to foreign legal systems and practices since they don’t have form requirements.
Instance of Bank Guarantees
Due to the general nature of a bank guarantee there are many kinds. Here are some things you need to know:
- A credit security bond serves as collateral for repaying a loan.
- A payment guarantee assures a seller the purchase price is paid on a set date.
- A confirmed payment order is an irrevocable obligation where the bank pays the beneficiary a set amount on a given date on the client’s behalf.
- A warranty bond serves as collateral ensuring ordered goods are delivered as agreed.
- An advance payment guarantee acts as collateral for reimbursing advance payment from the buyer if the seller does not supply the specified goods per the contract.
- A performance bond serves as collateral for the buyer’s costs incurred if services or goods are not provided as agreed in the contract.
- A rental guarantee serves as collateral for rental agreement payments.
Requesting for a Bank Guarantee
Bank guarantees are not limited to business customers; individuals can apply for them as well. However, businesses do receive the vast majority of guarantees. In most cases, bank guarantees are not particularly difficult to obtain.
To request a guarantee, the Issuer contacts the bank and fills out an application that identifies the amount of and reasons for the guarantee. Typical applications stipulate a specific period of time for which the guarantee should be valid, any special conditions for payment and details about the beneficiary.
Sometimes the bank requires collateral. This can be in the form of a pledge agreement for assets, such as stocks, bonds or cash accounts. Liquid assets are generally not acceptable as collateral.
Understanding Bank Guarantees Usefulness
Bank guarantees are often part of arrangements between a small firm and a large organization – public or private. The larger organization wants protection against counterpart risk, so it requires that the smaller party receive a bank guarantee in advance of work. Bank guarantees can be used by a variety of parties for many reasons:
- Assure a seller that a purchase price will be paid on a specific date.
- Function as collateral for reimbursing advance payment from a buyer if the seller does not supply the specified goods per the contract.
- A credit security bond that serves as collateral for repaying a loan.
- Rental guarantee that serves as collateral for rental agreement payments.
- A confirmed payment order – an irrevocable obligation, in which a bank pays the beneficiary a set amount on a given date on the client’s behalf.
- Performance bond that serves as collateral for the buyer’s costs incurred if services or goods are not provided as contractually agreed.
- Warranty bond that functions as collateral, ensuring ordered goods are delivered, as agreed.
Differences Between Bank Guarantees and Letters of Credit
Letters of credit are usually used in international trade agreements while bank guarantees are often used in real estate contracts and infrastructure projects.
Bank guarantees represent a much more significant commitment for banks than letters of credit. A bank guarantee, like a letter of credit, guarantees a sum of money to a beneficiary; however, unlike a letter of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations under the contract. This can be used to essentially insure a buyer or seller from loss or damage due to nonperformance by the other party in a contract.