Businesses sometimes need to guarantee payments and the best way to do so is to provide a bank guarantee, which ensure the creditor that payment will be made once the transaction is complete. It is a type of warranty that a bank provides individuals to provide loan, payment or services to start any business activity.
What is a Bank Guarantee?
This is a surety that is provided by a bank or a financial institution that they will pay off the debts and liabilities incurred by an individual or a business entity in case they are unable to do so.
This enables a business to grow and expand by deferring payment of goods and services they are utilizing now to a later date. This helps a business to invest on a larger scale than would have been possible without the bank guarantee.
Who Can Get a Bank Guarantee?
By providing a guarantee, a bank offers to honor any payment to the creditors upon receiving a request. This requires that the financial institution be very sure of the business or individual to whom the bank guarantee is being issued. So, banks run risk assessments to ensure that the guaranteed sum can be retrieved back from the business. This may require the business to furnish a security in the shape of cash or capital assets. Any entity that can pass the risk assessment and provide security may obtain a bank guarantee.
How Do Bank Guarantees Work?
The system for providing bank guarantees work like this:
- Applicant and the creditor ascertain that there is a need for a bank guarantee.
- Applicant reaches out to a financial institution to issue a bank guarantee to the creditor.
- The bank runs a risk assessment and asks for a security.
- The applicant furnishes the security and the bank, or the financial institution processes the bank guarantee.
- The bank guarantee is sent to the creditor’s bank or the creditor, or the applicant may be asked to collect it in person to give it to their creditor.
Advantages of Bank Guarantee
A business benefits from a bank guarantee as:
- It allows one to defer payment for goods or services procured on the basis of the security provided by the bank guarantee.
- All the money is not tied up in one project but can be spread around.
- There is the cash available to explore and expand business.
Types & Purposes of Bank Guarantees
There are in general two types of Bank Guarantee:
- Direct bank guarantee is a guarantee which is issued by the bank of the account holder directly in favour of the Beneficiary.
- Indirect guarantee is a guarantee which is issued by a second bank in return for a counter-guarantee.
A financial institution can provide many different types of bank guarantees. These include the following:
- Performance Guarantee (or Performance Bond) – these are bonds that act as collateral for any loss suffered by the buyer in case the performance of the seller is below par.
- Advance Payment Guarantee – this is to ensure the safety of any advance payment made by the buyers to the seller. In case the seller is unable to deliver the service or the goods, then the buyer can get his money back.
- Payment Guarantee – this guarantee is provided to the seller, ensuring payment by a predetermined date.
- Conditional Payment Undertaking – This is an instruction to the bank from an account holder to pay a sum of money to a creditor on completion of certain conditions. This bond is a post contract instrument that is used to pay off agents and contractor on completion of a project.
- Guarantee Securing Credit Line – This surety is given to a creditor on claims against the debtor in case a loan is not repaid as per the terms of the agreement.
- Order and Counter Guarantee – This is a surety given by the debtor to the creditor, to protect against the failure to fulfill an obligation as contracted. In case of default, the creditor can demand the payment back.