What is a bank guarantee
What is a bank guarantee: A bank guarantee is a ‘promise’ to underwrite or make payment to a third party, on certain terms. Often a third party will request a guarantee of payment upon dispatching its goods or services to another party, and a bank can guarantee this payment through a contractual obligation.
Bank Guarantee History and Defintion:
Guarantee stems from the Spanish word ‘garante’, in the 17th Century, meaning a ‘person giving something as security’.
How can a bank guarantee help a business?
A bank guarantee is a generic term and there are several types of bank guarantee that can help businesses.
As an example, say a small client is dealing with a multinational company on a project, they might require some form of promise to have the relevant financial backing to complete that project. A bank would conduct due diligence on the small company and would act as a ‘guarantor’ to the multinational company; ensuring that the small client will complete the project on certain terms.
A bank guarantee is a ‘surety bond’ which is often addressed to a larger institution of corporate by which the bank pledges (and contractually agrees) to pay an agreed amount under stipulated conditions.
Benefits of bank guarantees
Allows SMEs the ability to reassure end parties the ability to contractually pay and finance larger projects
They offer financial credibility and creditworthiness which is backed by a bank
Bonds, Guarantees and Indemnities can normally be issued by Trade Finance Global’s partner network, located in most geographies and markets around the world, specialising in different sectors
Contracts and terms can be negotiated as guarantees can be paid or issued in different currencies
Types of bank guarantees
1. Tender Guarantee (or Bid Bond)
If you are pitching to a large company for a tender or project, the buyer might want a ‘tender guarantee’ to show that you’re a serious potential candidate.
2. Advance Payment Guarantee
If you ask the buyer for up front deposit or part payment (often 10-20% up front of the contract price), your buyer might want reassurance of repayment if the contract terms aren’t fulfilled, or they default. A bank can offer this as an Advance Payment Guarantee, which acts as an insurance to return the deposit if the contract defaults.
3. Performance Guarantee
When working to tight deadlines, the buyer might wish to charge penalty fees if the terms of the contract have not been fulfilled to the stated deadline. Often the guarantee might still be in place, but an additional fee (or compensation) would be assured by the bank in the case of delays or errors.
4. Standby Letters of Credit
Standby Letters of Credit are also guarantee obligations from a banks within the United States, which forbids financial institutions from assuming guarantees, so where a bank guarantee might not be issued, a SLC is used in its place.
Bank guarantee eligibility: What do applicants have to do?
Applicants need to demonstrate financial credit worthiness to their bank, or the bank offering to guarantee payment to another party in order to access a guarantee.
The bank would normally look at previous trading history, recent accounts, credit history and liquidity. The bank would normally need to know how long the bank guarantee is required for, the amount and currency, beneficiary details and any other conditions that might be required. A bank might ask for some security over the guarantee (e.g. liquid assets such as property or equipment it holds, and maybe a personal or directors guarantee).
Here is an example of a Bank Guarantee, for illustrative purposes only, details have been removed:
Want to find out more about how a Bank Guarantee could work for your business? If you’re looking for a funder or bank to provide some form of guarantee or act as a guarantor on behalf of your company to allow you to fulfil larger contracts, offer confidence to an end buyer and grow, get in touch with our team or fill out the form here.
What’s the difference between a bank guarantee and a letter of credit?
A bank guarantee and a letter of credit are similar in many ways but they’re two different things. Letters of credit ensure that a transaction proceeds as planned, while bank guarantees reduce the loss if the transaction doesn’t go as planned.
A letter of credit is an obligation taken on by a bank to make a payment once certain criteria are met. Once these terms are completed and confirmed, the bank will transfer the funds. The letter of credit ensures the payment will be made as long as the services are performed.
A bank guarantee, like a letter of credit, guarantees a sum of money to a beneficiary. 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.
For example, an American wholesaler receives an order from a Canadian company. The wholesaler has no way of knowing whether the buyer can fulfill his payment obligations, and requests that a letter of credit be provided in their contract. The purchasing company applies for a letter of credit at a bank where it already has funds or a line of credit (LOC). After the goods have been shipped, the bank would pay the wholesaler its due as long as the terms of the sales contract are met such as delivery before a certain time or confirmation from the buyer that the goods were received undamaged. The letter of credit substitutes the bank’s credit for that of its client, ensuring correct and timely payment.
Bank guarantees insure both parties in a contractual agreement from credit risk. A construction company and its cement supplier may enter into a new contract to build a mall. Both parties may have to issue bank guarantees to prove their financial stance and capability. In a case where the supplier fails to deliver cement within a specified time, the construction company would notify the bank which then pays the company the agreed amount specified in the bank guarantee.
While letters of credit are used mostly in international trade agreements, bank guarantees are often used in real estate contracts and infrastructure projects.
What is the meaning of bank guarantee?
A bank guarantee is a guarantee from a lending institution ensuring the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank covers it.
What is the difference between letter of credit and bank guarantee?
A letter of credit is an obligation taken on by a bank to make a payment once certain criteria are met. … A bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary. Unlike a line of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations under the contract.