Bank Guarantees and Bonds are both considered financial instruments that act as sureties to protect the parties who enter into contracts to exchange goods and services.
These instruments guarantee the purchaser that in case of failure by the seller, they can impose the contractual obligations to be fulfilled.
Key Takeaways
- Bank guarantees are contractual agreements in which a bank ensures payment on behalf of its client if the client fails to fulfill obligations; bonds are debt securities issued by entities to raise funds, with an obligation to repay the principal and interest.
- Bank guarantees provide a safety net for transactions, reducing risk for the beneficiary; bonds are investment instruments that generate income for investors.
- Bank guarantees are contingent liabilities for banks, while bonds create debt for the issuing entity.
Bank Guarantee vs Bonds
A Bank Guarantee is a written agreement between a bank and a customer, where the bank commits to make payment to a third party if the customer fails to fulfill a contractual obligation. Bonds are debt securities issued by corporations, governments, and other entities to raise capital.
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A Bank Guarantee is often given along with a loan as a provision that if the borrower fails to repay the amount, the bank will cover the losses. At the same time, a Bond acts as a surety against one of the parties who agree to break it.
Bank Guarantees, also known as a letter of credit, ensure that payments between the seller and buyer go smoothly, whereas Bonds, also known as surety bonds, protect the parties from the risk of broken contracts.
Comparison Table
| Parameter of Comparison | Bank Guarantee | Bonds |
|---|---|---|
| Meaning (Definition) | A bank guarantee is when a lending institution, like a bank, stands as a guarantor and promises to cover the losses if the borrower fails to do so. | A bond can be considered a deal or agreement between the lender and borrower that acts as a surety of payment for either of the parties. |
| Issuers | A bank guarantee can be issued only by a bank as a surety for some individuals. | Bonds can be issued by banks, governments or even large companies to meet their significant needs for money. |
| Route of payment | In the case of a Bank Guarantee, the payment has to always go from the seller to the buyer through the bank. | In the case of bonds, the bank does not need to pay the bondholder and can keep its fee if there are no failures in payment. |
| Accounting | A Bank Guarantee is always considered a liability for the bank as it is a kind of obligation to pay it out. | A bond is a kind of insurance product and is therefore accounted for as an asset as long as the transaction goes smoothly. |
| Users | Individuals use Bank Guarantees for safer International and cross-border transactions, which helps businesses grow. | Governments and corporations usually use bonds to borrow vast amounts of money. |
What is Bank Guarantee?
A bank guarantee is a promise provided by a bank or any financial institution to a particular lender that if the borrower fails to repay the borrowed amount, the bank will act as a guarantor and take care of all the losses on behalf of the borrower.
Business entities usually use bank guarantees, which allow them to purchase equipment, raw materials, machinery, etc., with a surety that even if the borrower cannot repay the amount, the bank will stand accountable.
Bank Guarantees are usually highly-priced in nature and are valid for a longer time. They can be risky for banks by signing a bank guarantee; the bank agrees to pay whatsoever amount the borrower requests.
There are different kinds of Bank guarantees:
Deferred Payment guarantees:
As the word cites, these guarantees are issued for a certain fixed period and usually given to exporters. In case of failure, the bank has to provide the amount in instalments.
Financial Guarantee:
These kinds of guarantees are made with the condition that the bank will repay the party if there is any delay in the completion of the project or if it is not completed entirely.
Advance Payment Guarantee:
Advance payment is made to the service provider with the hope that he can provide his services on time. But if that is not done, these guarantees ensure that the buyer gets a refund of his payment.
Performance Guarantee:
These guarantees are usually made based on the performance of a particular service, wherein delay in performance, or inadequate service by the dealer leads to the bank paying amounts.
Foreign Bank Guarantee:
These guarantees are usually similar to the standard contracts except for the fact that these are offered on behalf of a foreign beneficiary or creditor.
What are Bonds?
A bank bond or surety bond is a kind of contract between three parties, i.e. the principal (the borrower), the surety (the bank or any financial institution) and the obligee (the lender), where the surety stands as a guarantee to the obligee that the principal will fulfil all the terms of the bond.
Bonds ensure that the contract entered by the parties works smoothly and is completed according to their mutually agreed upon terms.
They protect governments and consumers from fraud, misinterpretation, and malpractices, thus allowing businesses to flourish.
Although the bank or organization acting as a surety backs the bond and covers it up in case of losses, the principal must sign an indemnity agreement known as a general agreement of indemnity which includes all the businesses done by the principal along with its owners.
Some of the types of bonds are as follows:
Contract Surety Bond:
In these bonds, the principal is usually a project owner, and the bond guarantees that a contractor will follow every specification laid out in a contract and pay for all the expenses of his workers.
Commercial Surety Bond:
These kinds of bonds are usually mandated by government agencies and are used to protect the public interest. Here the oblige is the general public.
Fidelity Surety Bond:
These bonds usually protect a company from the malpractices or frauds done by employees who handle cash and finance departments. They are a kind of protection against people’s money and personal assets.
Court Surety Bond:
Lawyers or attorneys usually require these kinds of bonds before court proceedings to ensure they get their court fees and protect them from losses.
Main Differences Between Bank Guarantees and Bonds
- A Bank Guarantee is a way to transfer payment between the lender and the borrower. At the same time, Bank or surety bonds provide insurance against either of the parties to a contract from breaking it.
- Bank Guarantees are usually to be paid when the borrower fails to make the payment, while a bond is issued with a maturity date and must be paid on the end date along with interests.
- Bank Guarantees are usually on demand whenever the lender wishes to receive his money and the borrower cannot repay. At the same time, Bonds are conditional, i.e. have a lot of conditions attached to them.
- The main difference between Bank Guarantee and Bonds is that in a Bank Guarantee, money transfers not directly from a buyer to the seller but through the bank that acts as a guarantee. In contrast, in a Bond, the transaction occurs now between the parties if there is no failure on the borrower’s side.
- A Bank Guarantee is usually liable for the financial risk of the contracted project, while a Bond is liable for any performance risk posed by the principal.
- https://www.manchesterhive.com/view/9781847799913/9781847799913.00016.xml
- https://www.econstor.eu/handle/10419/168912
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
