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?
- 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 bank.
- Any person who has a good financial bank record is eligible to apply for a bank guarantee.
- The person’s eligibility criteria are decided by factors like transaction history, credit score, current assets, etc.
- The bank also considers the bank guarantee period, beneficiary details value; before approval.
- 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 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
| Advantages | Disadvantages |
| Commercial banks can be used by even small house-based business. Advantages | Commercial 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. |
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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.
