What is the Bank Guarantee (BG) ? How to Bank Guarantees Work ? What is the type of Bank Guarantees ? What is the Purpose of Bank Guarantee?

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Bank Guarantee

A bank guarantee is a guarantee from a lending institution ensuring the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank covers it. A bank guarantee enables the customer, or debtor, to acquire goods, buy equipment or draw down Loans, and thereby expand business activity.

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:

  1. Direct bank guarantee is a guarantee which is issued by the bank of the account holder directly in favor of the Beneficiary.
  2. 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.

IMPORTANT NOTES WHILE MAKING BANK GUARANTEE

  1. Date : Current
    1. Buyer’s Detail with complete address.
    2. Purchase order, seller’s offer No. PI.
    3. Payment Term (% of contract Value, always check with PO)
    4. Contract Value.
    5. Guaranteed Value : (% Calculation of Contract Value).
    6. Validity of Contract.
    7. Expiry Date
    8. Claim Period (whether Inclusive({11 month & 1 month for claim}) or Exclusive).
    9. Arbitration.

Supporting documents to submit bank guarantee.

  1. Letter to Bank for Issuance of BG. (On Letter Head)
  2. Declaration on E-Stamp.
  3. Application for Issuance of BG.(bank format)
  4. PBG LETTER/ABG LETTER as per Proforma
  5. PI Copy
  6. PO Copy

Note : Cancellation of a Guarantee: The beneficiary of the guarantee shall invoke the BG on or before the expiry date of the guarantee. The bank is discharged from its liability if no claim is received by it on or before validity period mentioned in the guarantee