A bank guarantee serves as a promise from a commercial bank that it will assume liability for a particular debtor if its contractual obligations are not met. In other words, the bank offers to stand as the guarantor on behalf of a business customer in a transaction. Most bank guarantees carry a fee equal to a small percentage amount of the entire contract, normally 0.5 to 1.5 percent of the guaranteed amount.
Applying 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 account holder 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. Illiquid assets are generally not acceptable as collateral.
How Bank Guarantees Work and Who Uses Them
There are several different kinds of bank guarantees, including:
- Performance guarantees
- Bid bond guarantees
- Financial guarantees
- Advance or deferred payment guarantees
Bank guarantees are often part of arrangements between a small firm and a large organization—public or private. The larger organization wants protection against counterparty risk, so it requires that the smaller party receive a bank guarantee in advance of work. A variety of parties can use bank guarantees 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 is 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 abeneficiary; 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 orsellerfrom loss or damage due to nonperformance by the other party in a contract.
FAQs
Bank guarantees are often part of arrangements between a small firm and a large organization—public or private. The larger organization wants protection against counterparty risk, so it requires that the smaller party receive a bank guarantee in advance of work.
What is the reason for bank guarantee? ›
Bank guarantees help businesses as creditors will get a proper reassurance that the loan amount will be repaid by the bank if the business is unable to repay the loan entirely on time. When a bank signs a bank guarantee, it promises to pay any amount according to the request made by the borrower.
What are the rules for bank guarantee? ›
The total volume of guarantee obligations outstanding at any time may not exceed 10 per cent of the total owned resources of the bank comprising paid up capital, reserves and deposits.
How long does it take to get bank guarantee? ›
For fully cash-secured facilities, with a customer limit up to $100,000, a Bank Guarantee can be in your hands within 5 – 8 business days.
Is it hard to get a bank guarantee? ›
In most cases, bank guarantees are not particularly difficult to obtain. To request a guarantee, the account holder contacts the bank and fills out an application that identifies the amount of and reasons for the guarantee.
How do I write a letter of request for bank guarantee? ›
ii) I/We hereby declare that all the particulars and information furnished in the application form are true, correct, complete and up-to-date in all respects. I/We have not withheld any information. iii) I/We hereby provide no objection for generation of Credit bureau report by Bank for processing of Bank Guarantee.
What is the disadvantage of bank guarantees? ›
- Disadvantages of a guarantee with a bank
While having only one point of contact can be an advantage, there are also disadvantages: Costs may be high and you have less flexibility. Your working capital may be limited. Costs from your bank or other lender may also be high, putting pressure on your expected margin.
What does it mean to invoke a bank guarantee? ›
It has been observed that a bank guarantee is a contract between the beneficiary and the bank. When the beneficiary invokes the bank guarantee and a letter invoking the same is sent in terms of the bank guarantee, it is obligatory on the bank to make payment to the beneficiary.
Who can be a guarantee? ›
Can anyone be a guarantor? Almost anyone can be a guarantor. It's often a parent or spouse (as long as you have separate bank accounts), but sometimes a friend or relative. However, you should only be a guarantor for someone you trust and are willing and able to cover the repayments for.
How do guarantees work? ›
A guarantee is a promise to fix, free of charge, any faults which might arise within a certain period. A written guarantee is better than one given verbally.
As per this act, Bank Guarantees must have a limitation period, and the claims can be made on them only within this period. Usually, the limitation period for Bank Guarantees in India is 12 months over an above Expiry date of bank Guarantee If a claim is not filed on a Bank Guarantee within this period, it expires.
WHO issues bank guarantee? ›
A bank guarantee is a guarantee given by the bank on behalf of the applicant to cover a payment obligation to a third party. In other words, the bank becomes a guarantor and is answerable for the person requesting the guarantee in the event that they are unable to make the payment they have agreed with a third party.
Is it safe to have a bank guarantee? ›
Risks for Lenders Credit Lining a Bank Guarantee
There is no particular risk to the lender, but even though they are fully secured, they will not offer a credit line or loan to the Beneficiary if they feel the underlying transaction is not strong enough to fulfil the obligation of repayment.
Who holds a bank guarantee? ›
A Bank Guarantee is an undertaking by the Bank that payments to your customers and suppliers will be met, without tying up working capital. The Bank holds your cash or assets as security for the guarantee. You provide your supplier with the guarantee instead of cash.
