Bank Guarantee

What is a Bank Guarantee?

A bank guarantee is a financial instrument wherein a bank acts as the guarantor of the liabilities undertaken by the borrower/applicant. In other words, the bank agrees to pay the amount in case the borrower is not able to fulfil the conditions of the agreement.

Non-availability or shortage of timely funds is a common phenomenon in businesses, the reasons of which can be manifold-- from deferred payments to their slow growth.

Moreover, organizations are often unable to take up new projects due to financial crunch and get trapped in a vicious cycle, thus leading to their downfall.

Fortunately, the situation can be mitigated up to a great extent by employing various financial instruments. A bank guarantee is one such arrangement that business can use to temporarily cover for the lack of credit.

Deferred payment guarantee

A deferred payment guarantee is the most common type of bank guarantee. Here, if the buyer fails to pay within the duration that is agreed upon by both parties, the bank takes the liability of paying the seller for the goods/services. Under the deferred payment guarantee, the bank makes the payment to the seller in instalments in the event of non-payment by the buyer.

Financial guarantee

A financial guarantee is used in situations when a company promises to complete a project within a particular timeframe and receives funds for the same. The financial guarantee from a bank states that the money will be returned to the client if the company is not able to finish the project within the stipulated time frame.

Advance payment guarantee

Under the advance payment guarantee, the buyer makes an advance payment to the seller. However, this amount is refunded by the bank in case the seller fails to deliver the goods as per the contract terms.

Foreign bank guarantee

A foreign bank guarantee is used in international trade deals. While most bank guarantees involve only one bank, a foreign bank guarantee may involve two banks-- one from each country.

Performance guarantee

A performance guarantee means that the bank will provide compensation to the buyer or recipient of the services if the goods/services are of inferior quality and don’t meet the standards that have been mutually agreed upon by both the parties.

Bid bond guarantee

Bid bond guarantees are used during the bidding process for a project. When any project is up for bidding, multiple contractors compete to win it. The company or the institution awarding the project asks for a bid bond guarantee from all the bidders. This guarantee means that if the bid is accepted, the contractor will take up the project and execute it as per the required standards.

If a contractor is awarded the project but is unable to take it up, the guarantee is evoked by the company and the bank makes the payment. The amount of a bid bond guarantee is generally 5-10% of the estimated project cost.