What is a bank guarantee?

A bank guarantee is a commitment made by a bank to assume the payment obligations of an applicant towards a third party. In simpler terms, the bank takes responsibility for fulfilling the guarantee to the requesting party if the applicant fails to meet their payment obligations to the third party. This means that the bank becomes liable to the requesting party if it cannot act as a guarantor and pay the payment due to the third party.

What is a bank guarantee?

A bank guarantee is a form of financial assistance offered by a lender to a borrower. It involves the bank pledging to ensure that the borrower meets their debt obligations to the creditor. This means that if the borrower fails to repay the debt, the bank will step in and cover the outstanding amount. Bank guarantees are commonly used by customers or debtors to secure purchases of goods, equipment or to obtain loans.

How does a bank guarantee work?

A bank guarantee is a crucial document that assures the lender will cover the transaction amount if the borrower fails to make the payment. This document is critical for ensuring certainty in the world of commerce. Bank guarantees enable companies to purchase goods or services that are difficult to obtain without this kind of assurance. As a result, bank guarantees not only increase entrepreneurial activity but also enhance corporate activity.

Bank guarantee term

Bank guarantees may be open-ended, meaning they have no expiration date, or have a specified end date. In the case of rental property, the deposit amount is determined as a monthly payment requested by the landlord. Upon approval of the transaction, the bank issues a bank guarantee to the applicant, who then provides a copy to the landlord. To obtain the guarantee, the client is required to pay various fees, including tuition fees, processing fees, and a monthly fee.

If the applicant fails to comply with the terms of the lease, the landlord can request monthly unpaid payments from the bank over a period of time. To do so, the landlord must prove the nonpayment of these monthly payments. Once the monthly payment is completed, the bank can charge the applicant.

When the guarantee expires without any issues, the bank terminates the guarantee and the contract. Customers who have received a guarantee must return the physical guarantee to cancel it normally.

Type of Bank Guarantee

Bank guarantees are provided for a specific amount and a predetermined period of time. The guarantee outlines the circumstances under which it may be invoked for a contract. Bank guarantees can be financial or performance-based.

In a financial bank guarantee, the bank assures that the buyer will repay any outstanding debt to the seller. If the buyer fails to do so, the bank will assume the financial burden in the form of a small fee charged to the buyer when the guarantee is issued.

In a performance-based guarantee, the beneficiary can seek compensation from the bank for the failure to meet the obligations set forth in the agreement. If the other party fails to perform as promised, the beneficiary can sue the guarantor bank for damages resulting from the default.

In the case of foreign bank guarantees, such as international export transactions, a third party bank may operate in the beneficiary's country of residence.

Bank Guarantee vs. Letter of Credit

In most cases, banks only take action if the buyer defaults or fails to repay the debt. A single breach or delay in a project is unlikely to prompt the bank to intervene. However, in the case of a letter of credit, the buyer or seller initiates the claim with the bank.

As letters of credit involve greater bank involvement, they provide greater assurance that debts will be paid on time or resolved as agreed. In contrast, banks take a more cautious approach when it comes to bank guarantees. They require proof that the contract is not being fulfilled before they become involved.

The importance of bank guarantees

Bank guarantees provide peace of mind for business operations by removing obstacles such as lack of payment or delivery of goods and services.

They also improve creditworthiness by demonstrating the bank's confidence in the business, indirectly verifying its reliability.

Bank guarantees can reduce risk by providing a pre-payment guarantee to protect the buyer. If the seller fails to deliver the goods or services, the buyer is guaranteed a refund of the upfront payment.

In addition, bank guarantees can help evaluate the reliability of parties involved in foreign transactions, which is a complex process. They provide financial stability in such situations.