What is a Bank Guarantee?
A bank guarantee is offered by a financial institution promising to cover a financial obligation if one party in a transaction fails to hold up their end of a contract. A bank guarantee enables the bank’s client to acquire goods, buy equipment, or perform international trade. If the client fails to settle a debt or deliver promised goods, the bank will cover it. In layman’s language, a bank guarantee is a promise by a financial institution to meet the liabilities of a business or individual if they don’t fulfill their obligations in a contractual transaction.
There are a number of bank guarantees:
- Performance Bank Guarantee: Performance bond guarantee serves as collateral for the buyer’s costs if services or goods are not provided as agreed in the contract.
- Advance payment guarantee: Advance payment guarantee acts as collateral for reimbursing the buyer’s advance payment if the seller does not supply the specified goods per the contract.
- Warranty bond guarantee: Warranty bond guarantee serves as collateral, ensuring ordered goods are delivered as agreed.
- Payment guarantee: Payment guarantee assures a seller the purchase price is paid on a set date.
Bank Guarantee Process
A bank guarantee process usually involves the following steps:
- First, an applicant will ask for a loan from a beneficiary or creditor.
- While applying for the loan, these 2 parties will agree that a bank guarantee is necessary.
- Then, the applicant will request a bank to provide a bank guarantee for the loan taken from the creditor. The bank guarantee will be taken on behalf of the creditor.
- The bank will now offer the bank guarantee to the applicant and send financial instructions to an advising bank.
Advantages of Bank Guarantees
To the applicant:
- Small companies can secure loans or conduct business that would otherwise not be possible due to the potential riskiness of the contract for their counterparty. It encourages business growth and entrepreneurial activity.
- The banks charge low fees for bank guarantees, normally a fraction of 1% of the overall transaction, for the assurance provided.
To the beneficiary:
- The beneficiary can enter the contract knowing due diligence’s been done on their counterparty.
- The bank guarantee adds creditworthiness to both the applicant and the contract.
- There is a risk reduction due to the bank’s assurance that they will cover the liabilities should the applicant default.
- There is an increase in confidence in the transaction as a whole.
A bank guarantee helps to establish trust and certainty between buyers and sellers. A bank guarantee serves as a risk management tool for the beneficiary, as the bank assumes liability for completion of the contract should the buyer default on their debt or obligation