What is a bank guarantee?
A bank guarantee is a promise from a bank or other lending institution that if a particular borrower defaults on a loan, the bank will cover the loss. Note that a bank guarantee is not the same as a letter of credit. Also, a bank guarantee is a kind of guarantee from a lending organization.
The bank guarantee signifies a lending institution ensures that the liabilities of a debtor are going to be met. In other words, if the debtor is unsuccessful to settle a debt, the bank will cover it. A bank guarantee allows the customer, or debtor, to acquire goods, purchase equipment or draw down a loan.
Bank Instrument Description:
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Types of Bank Guarantee
It is important that guarantee can be enforced based on terms of the contract (i.e. guarantee agreement) existing between the bank and the beneficiary. Generally, beneficiaries do state a clause to be included for charging penal interest in the case of delayed payment. Hence, it is essential for the bank to be cautious while finalizing the format and text of the contract (the guarantee agreement). While signing the same, the provision of penal interest and clauses attached to delays and default are to be carefully noted.
Why is Bank Guarantee Important?
BGs reflect the confidence of the bank in your business and indirectly certify the soundness of your business.
When new parties associate in the business and are skeptic about the performance of the company undertaking the project, performance guarantees help in reducing the risk of the beneficiary.
In the case of foreign transactions or transactions with Government organizations, the foreign party or a Government Undertaking is constrained and cannot assess the soundness of each and every applicant to a project. In such cases, BGs act as a trusted instrument to assess stability and creditworthiness of companies applying for projects.
Advance payment guarantees act as a protection cover wherein the buyer can recover the advance amount paid to the seller if a seller fails to deliver the goods or services. This protects against any probable loss that a party can suffer from a new seller.