What is Bank Guarantee? | Working, Types, Examples, Pros and Cons

A guarantee usually means giving something as security. A bank guarantee is offered by a lending organization that promises to pay for forfeiture if a debtor defaults on money or voids contract obligations within certain regulations.

The guarantee increases company’s purchase power and in turn grow business.

There are 2 primary kinds of assurances by the bank, namely direct (for the overseas transaction) and indirect (for export trading).

How does bank guarantee work?

  1. A bank guarantee requires eligibility criteria that a person has a good financial track.
  2. The bank guarantee can be applied in any bank apart from the account holder’s bank.
  3. Any person who has a good financial bank record is eligible to apply for a bank guarantee.
  4. The person’s eligibility criteria are decided by factors like transaction history, credit score, current assets, etc.
  5. The bank also considers the bank guarantee period, beneficiary details value; before approval.
  6. In some rare cases, banks will require some form of collateral.
  7. After meeting the satisfaction criteria of the banking personnel, you’ll get the necessary approval for the guarantee.

Types of Bank guarantees:

A bank guarantees is applicable for a specific amount and a predetermined period of time.

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 fulfilling the obligations of the contract completely. In case of a non-performance, the bank repays the beneficiary.

Advance payment

The bank acts as a guarantor and returns the advance payment in case of non-fulfillment of the contract terms.

Payment / Loan

The bank acts as a guarantor for payment/loan repayment. In the case of non-fulfillment of the payment, the banks pay the default amount.

Bid agreement

The bank acts as a guarantor for the bidder and makes sure the contract is undertaken.

Foreign banks

The bank acts as a guarantor for the foreign beneficiaries.

Advantages and Disadvantages of Bank guarantee

AdvantagesDisadvantages
Commercial banks can be used by even small house-based business. AdvantagesCommercial banking accounts are often 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 generally charge low fees for guarantees, generally 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.   

References

https://www.manchesterhive.com/view/9781847799913/9781847799913.00016.xml