A guarantee means giving something as security. A lending organisation offers a bank guarantee that promises to pay for forfeiture if a debtor defaults on money or voids contract obligations within certain regulations.
The guarantee increases the company’s purchase power and, in turn, grows the business.
There are 2 primary kinds of assurances by the bank, namely direct (for the overseas transaction) and indirect (for export trading).
- A bank guarantee is a financial instrument used to assure a third party that a bank will pay on its client’s behalf.
- It is required in business transactions as collateral to minimize risks and secure payment obligations.
- Bank guarantees can come in various forms, such as performance, payment, and advance payment guarantees.
How does a bank guarantee work?
- A bank guarantee requires eligibility criteria that a person has a good financial track.
- The bank guarantee can be applied in any bank apart from the account holder’s.
- Any person who has a good financial bank record is eligible to apply for a bank guarantee.
- Transaction history, credit score, current assets, etc., determine the person’s eligibility criteria.
- Before approval, the bank also considers the bank guarantee period and beneficiary details value.
- In some rare cases, banks will require some form of collateral.
- After meeting the satisfaction criteria of the banking personnel, you’ll get the necessary approval for the guarantee.
Types of Bank guarantees:
A bank guarantee is applicable for a specific amount and a predetermined period.
The bank acts as a guarantor on behalf of the applicant. In case the applicant fails to repay, the bank repays on the behalf and charges a small initial fee.
The bank acts as a guarantor for completely fulfilling the contract’s obligations. In case of non-performance, the bank repays the beneficiary.
The bank acts as a guarantor and returns the advance payment in case of non-fulfilment of the contract terms.
Payment / Loan
The bank acts as a guarantor for payment/loan repayment. In the case of non-fulfilment of the payment, the banks pay the default amount.
The bank is a guarantor for the bidder and ensures the contract is undertaken.
The bank acts as a guarantor for the foreign beneficiaries.
Advantages and Disadvantages of Bank Guarantee
|Even small house-based businesses can use commercial banks. Advantages
|Commercial banking accounts are more expensive than traditional bank accounts Disadvantages.
|Bank guarantee results in reducing the financial risk involved in the business transaction.
|The financial transactions and position of the business can be time-consuming.
|Small businesses can secure loans/conduct business without worrying about potential risks.
|The banks don’t give a guarantee for loss-making or high-value transactions easily.
|Banks charge low fees for guarantees, 1% of the overall transaction.
|Banks may need some form of collateral for certain transactions.
|The BG requires fewer documents and is processed faster by the banks.
|The transactions involving BG are considered more creditworthy.
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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.