A bank guarantee is a promise by a bank or other financial institution that the bank or financial institution will pay for losses if a particular borrower fails to repay a loan.
Through this bank guarantee, the bank assures the original creditor that if the borrower defaults on its obligations, the bank will pay for them.
Similar to bank guarantees, we can opt for a personal loan
A bank guarantee is a contract between three different parties, including:
- The applicant (the party applying for a bank guarantee from the bank and taking out a loan from a creditor).
- The beneficiary (the party receiving a partial guarantee)
The bank (the party that agrees to sign the guarantee and pledges payment if the applicant fails to repay the loan).
Bank guarantees are very often used by companies. With the help of a bank guarantee, the debtor, borrower or customer can acquire equipment, machinery, raw materials, additional funds, etc. for business purposes. Bank guarantees help businesses because creditors have the assurance that the loan amount will be repaid by the bank if the business is unable to repay the loan in full and on time.
When a bank signs a bank guarantee, it promises to pay any amount according to the request of the borrower. Therefore, signing a bank guarantee is highly risky for banks.
Understand the bank guarantee process.
- First, an applicant applies for a loan from a beneficiary or a creditor.
- When applying for the loan, these two parties agree that a bank guarantee is required.
- Then, the applicant asks a bank to provide a bank guarantee for the loan taken out by the creditor. The bank guarantee is taken on behalf of the creditor.
- The bank now offers the bank guarantee to the applicant and sends a financial instruction to a consulting bank.
Types of bank guarantees
- Deferred Payment Guarantee: this is a bank guarantee or payment bond offered to the exporter for a deferred period or for a specified period of time. When a buyer purchases capital goods or machinery, the seller extends credit to the buyer if the buyer’s bank guarantees payment of the buyer’s outstanding debt to the seller. Under this type of guarantee, the bank will make payment in installments if the delivery of raw materials, machinery, or equipment fails.
- Financial Guarantee: a financial bank guarantee assures the repayment of funds if the party fails to complete a particular project or operation. Under the financial guarantee agreement, the bank will make payment if there is a delay in completing the project.
- Guarantee for an advance payment: in this type of guarantee, an advance payment is made to the seller. It also guarantees that the buyer will receive payment back if the seller fails to deliver the service or product correctly or on time.
- Foreign Bank Guarantee: a foreign bank guarantee is provided by a bank on behalf of a borrower. It is offered on behalf of the foreign beneficiary or creditor.
- Performance Guarantee: under a performance guarantee, the bank provides compensation if there is a delay in the performance of the service or operation. Payment must be made even if the service is rendered inadequately.
- Bid bond: In this type of bond, a bidding process takes place. This is conducted by the contractor for the owner of an infrastructure or industrial project or operation of any kind. The contractor of the project guarantees that the best or highest bidder will have the ability and authority to complete a project to its specifications. The bid bond shall be delivered to the owner of the project as a guarantee certificate, and the guarantee shall mean that the project must be carried out in accordance with the bid contract.
Comparison between bank guarantee and letter of credit
There is often confusion between bank guarantee and letter of credit. However, it should be understood that the two are quite different.
A bank guarantee is a commercial or financial instrument provided by a bank, where the bank assures or guarantees a beneficiary that it will make payment to the bank if the actual customer fails to meet its obligations. The bank makes payment on behalf of the customer who has requested a bank guarantee.
A letter of credit, on the other hand, is a written promise or undertaking by a bank or other financial institution or company to a specific seller that payment will be made to the seller if the seller performs as specified in the letter of credit. In order for the bank to make payment on behalf of the original buyer, there must be documentary evidence that the seller has properly handled the transaction by delivering the correct product or service on time. The seller receives a guarantee from the bank that the seller will definitely pay the amount on behalf of the original buyer as soon as the obligations are fulfilled.
If the buyer is unable to make payment to the seller or creditor, the bank pays the specified amount to the seller as the obligations under the contract are not fulfilled. With a letter of credit, on the other hand, the bank makes payment to the seller as soon as the seller has delivered. This is because the seller has fulfilled the required obligations.
Bank guarantees are usually competitively priced. They are usually valid for a long period of time. The term of a bank guarantee is usually long. In addition, bank guarantees are accepted in almost all countries. Bank guarantees are available in Indian rupee as well as in currencies of other countries. Therefore, they are very useful for global transactions with parties in different foreign countries.
Can I apply for a bank guarantee online?
Yes, you can apply for a bank guarantee online.
Can I opt for a bank guarantee if I have a savings account?
Yes, you can opt for a bank guarantee if you have a savings account with the bank.
How long does it take for the bank guarantee to be issued?
Depending on the bank, it takes different time for the bank guarantee to be issued.
What documents must be submitted for the bank guarantee if I have a checking account?
If you are a current account holder, please find below a list of documents to be submitted:
-Text of the bank guarantee (Word format)
-Stamp paper (in accordance with the State Stamp Act)
-In case of a limited liability company, the resolution of the board of directors must be submitted.
What collateral must be provided for the use of the bank guarantee?
The bank guarantee is provided against the security or 100% of the available fixed deposit. However, the performance of the previous year is taken into account when the bank provides a bank guarantee.
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