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Bank Guarantee

  • 20-Feb-2024

Bank Guarantee 

Bank guarantee is a financial commitment that is given by the bank to a beneficiary on behalf of the applicant. It is used to provide assurance and reduce risk. It is a legally binding instrument on which the beneficiary can claim his compensation from the bank. 

Types of bank guarantees  

1. Performance Guarantee - This bank guarantee guarantees that the applicant will carry out his end of the bargain in accordance with the conditions of the contract. If the applicant fails to do so, the beneficiary will receive the guarantee amount from the bank. 

2. Payment Guarantee: The bank issues it on the buyer's behalf. In this type of guarantee, the supplier is assured that the payment is made according to the agreed-upon terms. If the goods are delivered according to the agreed-upon terms. 

3. Bid Bend: The debtor guarantees the project owner, if the work contract is awarded to him, he will complete the project according to the agreed terms. 

4. Advance Payment Guarantee: It is a type of surety issued by a bank or other financial institution. It is given to protect the beneficiary against the risk of non-performance by the buyer in a commercial transaction. This guarantee assures the seller that they will receive the agreed-upon advance payment even if the buyer fails to fulfil their contractual obligations. 

5. Financial Guarantee: It acts as a safety net in various financial transactions, ensuring a specific payment or fulfilling an obligation if someone fails to do so. It's like having a security guard watch over your financial interests. 

6. Retention Money Guarantee: It is a specific type of financial guarantee issued by a bank or insurance company. It is primarily used in construction or procurement contracts. It aims to ensure that the seller or contractor fulfils their contractual obligations even after receiving the final payment. 

7. Counter Guarantee: It is  issued by one bank to another. If a bank insures another beneficiary bank, it will fulfil its commitment. 


Purpose of Bank Guarantee  

  • To assure security and reduce risk in business transactions. 
  • To build trust between two partners. 


Addition features of Bank Guarantee 

A bank guarantee is a promise by the bank that if the applicant fails to fulfil his commitment, the issuing bank will pay his loss to the beneficiary. While the seller of credit is the commitment of payment by the issuing bank when a specific document is presented to the issuing bank,. 

- bank guarantee is not transferable to any third party unless the issuing bank gives its consent. 

- confirmation bank guarantee is issued by a bank, and in a confirmation bank, two banks are additionally involved, whereas in an unconfirmed bank guarantee, only the applicant's bank is involved. 

- The period of the bank guarantee can be extended if both the party and the issuing bank agree to it. 

- bank guarantee can also be listed in electronic form. 

- Bank guarantees can also be enforced in international transactions. 

- There is a "force majeure" clause in the bank guarantee, which means that there may be some unforseen situation due to which the beneficiary is not able to fulfil his obligation timely, then the issuing bank can give some relaxation to the beneficiary. 

- Bank guarantee mitigates risks in international business transactions. This risk can be of non-payment, non-performance or obligations related to other contracts 

- Banks charge commissions for issuing bank guarantees. This commission can range from 0.50% per year to 3%. This commission is charged at the time the bank actually issues the bank guarantee. 

- Bank guarantee issuing period can range from 3 months to 10 months. 

- Stand letter of credit is a type of letter of credit in which the buyer's bank will pay the seller if the buyer does not make the payment by the due date. A bank guarantee involves one bank, whereas multiple banks are involved in a standby letter of credit. 

- Bank guarantee is a contingent liability; hence, its value is not reflected in the balance sheet. 

- Bank guarantee automatically devolves when the bank tenure of the bank guarantee ends or the applicant has made the payment to the beneficiary. 

- When the bank guarantee expires, the bank returns the margin money to the applicant. 

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