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).
Key Takeaways
- 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.
Financial
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.
Performance-based
The bank acts as a guarantor for completely fulfilling the contract’s obligations. In case of non-performance, the bank repays the beneficiary.
Advance payment
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.
Bid agreement
The bank is a guarantor for the bidder and ensures the contract is undertaken.
Foreign banks
The bank acts as a guarantor for the foreign beneficiaries.
Advantages and Disadvantages of Bank Guarantee
| Advantages | Disadvantages |
| 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. |
Last Updated : 11 June, 2023
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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.
Interesting article, but I think more information on specific examples of bank guarantees would have been helpful.
I agree, real-life examples would complement the post’s theoretical information.
I’d like to see a section on the cultural and global implications of bank guarantees to make this even more comprehensive.
That’s a great suggestion. It would add an interesting layer to the discussion.
The advantages and disadvantages section provides a useful insight into the considerations to be made.
This is a very dry topic, but the post makes it quite engaging. I appreciate the effort that went into making it reader-friendly.
Agreed, such posts turn people off, but the clear writing here makes it very readable.
It’s a well-organized post with valuable content, that’s for sure.
I disagree with the advantages and disadvantages presented here. It seems to oversimplify the topic.
I understand your concern, however, I think the post provides a good overview for beginners.
The types of bank guarantees were well-explained, making it easier to understand how they work in various situations.
Yes, the diversity in types provides a thorough understanding of bank guarantees’ applications.
It’s a useful post for those seeking an overview of bank guarantees.
This is a thorough discussion of bank guarantees. Thank you for simplifying such a complex topic.
Well-written and informative. It’s great to understand the different types of bank guarantees and their value.
Really helpful and easy to understand. The advantages and disadvantages are particularly insightful.
The post makes this intricate topic clearer for sure.
This is very accurate information and it really helps to understand the importance of bank guarantees in business transactions.
It’s a great help for those new to business finances to learn about the types of bank guarantees available.
I totally agree, the more one knows about such an important financial instrument, the better.
I’m not completely convinced and would like to see more citations and references to support these claims.
I second this. More references would strengthen the post’s reliability.