Bank Guarantee Described

Introduction.

Bank Guarantee (BG) is an assurance from a bank or other lending institution that if a particular borrower defaults on a contract, the bank will cover the payments. Generally, bank guarantee is a facility designed to ensure that that the lender will cover all the liabilities of a debtor.

Three parties are involved in Bank Guarantee agreement viz. the Bank, the Beneficiary, and the applicant. The beneficiary is the one to who seeks the security of fulfillment of contract and the applicant is the party who has to issue bank guarantee from the bank. Bank as a mediator settles the issues of trust and credit issuing Bank Guarantee. Let us understand the concepts involved in BG with an example below.

Example:

ABC is a car dealer and XYZ a car manufacturer situated in foreign nation. ABC orders for 100 cars to be supplied in few days. Since XYZ is a foreign entity, it takes around 50 days for the cars to reach the warehouse of ABC. Currently there is a shortage of cash in ABC as the cash cycle for ABC is 45 days.

Two major issues arise here. One is the trust issue between two parties of whether ABC will provide payment for the goods sold in credit or whether XYZ will supply goods if payment is made early. In order to provide assurance in this condition a third party Bank Guarantee comes in handy. Before supplying the goods to the dealer, the manufacturer requests the dealer to issue a valid bank guarantee for the payment. After the issue of BG, the manufacturer will supply the goods and when the goods reaches warehouse of dealer, the payments are made to manufacturer.

Features of Valid Bank Guarantee;

For a BG to be valid, following items has to be explicitly present in the BG

  • Time Period of the Guarantee. ( Can range from few months to 10-20 years for large govt. contract)
  • Guaranteed Amount.
  • Purpose of the Guarantee has to be clearly specified.
  • Events under which the Guarantee can be invoked.
  • Collateral for which the Guarantee is issued: Bank Balance, FD, etc.
bank guarantee types

Types of Bank Guarantee

Based on the use case and types of trade, BG are classified as follows:

Performance Guarantee:

This Guarantee is issued for completion of work in prescribed quality in prescribed time limit. It is invoked when the work is not completed in time or when the work done does not meet the prescribed quality requirements. This guarantee is  generally issued by large contractors and construction businesses.

Financial Guarantee

This guarantee is also called Trade Guarantee. It is issued for completion of trade or supply of materials in specified amount for specified quantity or time period. It is also issued in case of international trade like in above example.

Deferred Payment Guarantee:

This guarantee is issued for assurance of the payments to be made in the future. For example, bank may issue deferred guarantee from the customers to pay the installments within the prescribed time.

Bid Bond Guarantee:

When government calls tender for purchase of machineries or equipment, it asks all the tender participants to provide a guarantee of fixed amount/certain % of purchase to prevent from the loss occurred in case the selected party backs from the contract. This type of guarantee is bid bond guarantee.

Advance Payment Guarantee.

This guarantee is designed to prevent the advance supplier from the loss if the party to whom the advance payment had been made for purchase of goods or services flees away without providing goods or services.

What is the limit of bank guarantee?

In case some company or firm has regular requirement of BGs in their course of business, banks also provide a facility of fixing “BG Limit” for that company/firm after BG assessment based on their track record, financial position, security offered by the company, margin and financial position of the business. Meaning such companies can get BG above their collateral. This BG limit is also called Non fund Based Limits.

Importance of Bank Guarantee:

  • Risk Reduction.
  • Confidence in trade and business.
  • Promotes international Trade.

Tags : 

Blogs,Economy,Entity Acts,Finance Literacy,Personal Finance

Share This : 

Leave a Comment

Your email address will not be published. Required fields are marked *

error: Genuine people have been working hard to provide these resources. Preventing illegal copying and copyrights protect their livelihood. BE SMART!! DONT COPY.