What is Bank Guarantee? (With uses & Example)

Bank Guarantee (BG) becomes a very popular commercial tool in present business. The BG is used for several purposes, like, the seller of commodity wants the security of his credit sales revenue, and the client wants the appropriate service from the contractors. If the buyer fails to pay the due amount within a reasonable time or ignores the sellers request, the seller can encash the BG. Again, if the contractor doesn’t perform as per the agreement or as per the specification, the client can also encash the BG. Actually, the Bank is doing all the process and taken the responsibility on behalf of clients.

Definition of a Bank Guarantee:

Bank Guarantee is the promise of a commercial bank where the commercial bank gives a guarantee to settle the liability of a particular debtor if contractual obligations are not met. The bank offers to stand as the guarantor on behalf of a business customer in a transaction. The normal Bank Guarantee fee is 0.5% to 1.5% of the guaranteed amount.

When the customer fails to pay the guaranteed amount, the bank will cover the loss on behalf of customers. Subsequently, the bank will recover the money from the client. Bank Guarantee protects the company from the probable losses.

How Bank Guarantee is initiated?:

Bank Guarantee is the agreement between 3 parties i.e the bank, the beneficiary and the applicant. The applicants of bank guarantee is one who seeks the bank guarantee from the bank and the beneficiary is one who takes the bank guarantee. Business Customer and Individual customer both may use bank guarantees to secure the sales amount. Bank Guarantee is not difficult to obtain. The Account holder contacts the bank and fills out an application that identifies the guaranteed amount of and the reason for the guarantee. Applications mention a specific period of time for which the guarantee should be valid and any special condition for the payment and details about the beneficiary. Collateral may require some time. This can be in the form of a pledge agreement for assets, such as stocks, bonds or cash counts. However, liquid assets are not acceptable for collateral. Bank Guarantee are an important banking arrangement and play a vital role in promoting international and domestic trade.

Types of Bank Guarantee:

There are several types of Bank Guarantee a business can be used, such as:

  • Performance Guarantee – is made between a client and the contractor to ensure that work will be done as per the agreement.
  • Bid Bond Guarantee – Through Bid bond contractors ensure that the contractors will ensure the bid contracts and will fulfill the job responsibilities at agreed price.
  • Financial Guarantee – Given the guarantee to take the responsibility for another company’s financial obligation if that company can not meet its obligations.
  • Advance or deferred payment guarantee

Why Bank Guarantee is Needed?:

Through bank guarantee the bank assures the customers regarding the receivable amount. Before issuing bank guarantee in favour of applicant, bank collects the information of applicant and try to confirm whether the applicant can pay the guaranteed amount within the mentioned time. Bank Guarantee reduces the counter party risks. Normally, financial institution is very sure regarding the financial health of the applicant.

This arrangement is made commonly between a small firm and large organization – Public or Private. The larger organization wants protection against Counter party Risk, so it requires that smaller organization receive a bank guarantee in advance of work.

Examples of Bank Guarantee::

 Here are some common examples of Bank Guarantee:

Payment Guarantee:

The sellers are assured by the bank the sells price will be paid by the purchaser on a set date.

Advance Payment Guarantee:

This is the Collateral for reimbursing advance payment from the buyer if the seller does not supply the specified goods as per the contract.

Credit Security Bond:

This is the collateral for repaying the loan

Performance Bond:

A Collateral for the buyer’s costs incurred if services or goods are not provided as agreed in the contract.

Warranty Bond:

Collateral ensuring ordered goods are delivered as agreed.