Bank Guarantee-Know it before you make Mistakes [Types, Example, Advantages]

Things You Should Know About Bank Guarantee and Use it to Your Advantage. This article helps you know each and every details about Bank Guarantee with examples and samples. Also find link to banks that offers Online Bank Guarantee applications.

Table of Contents

Bank Guarantees: What Are They and How Do They Work?

What is a Bank Guarantee?

A bank guarantee is a financial assurance agreement that a loan providing institution offers. A bank guarantee is a promise by a lender that they will meet and settle the debtor’s obligations. The bank guarantees that the debtor will pay the bank if he or she fails to settle the debt without raising any default scenario. However the bank guarantee allows the customer or debtor to invest in stocks like purchase goods, equipment, or take out a loan for any financial need.

The Key Points of Bank Guarantee

  • A bank guarantee is a promise by a lender to pay a loss in the event that a borrower defaults in paying his/her dues.
  • Bank Guarantee receivable client may choose to receive direct guarantees for cross-border and international transactions.
  • Bank Guarantees are a significant banking arrangement that aids in the promotion of both international and domestic trade.
  • Lenders are exposed to additional risk when they guarantee loans. As a result, these loans will have higher interest rates and costs.

Understanding and Bank Guarantee Meaning

The meaning of bank guarantee is a promise by a lender to pay a loss in the event that a borrower defaults. You may also say a bank guarantee is a commitment given by a bank to a third party that it would assume payment risk on behalf of its clients.This guarantee allows a company to buy things it wouldn’t otherwise be able to, which can help promote business growth and entrepreneurial activity.

To safeguard the third party from financial losses, such guarantees are commonly generated in corporate and personal transactions. A bank guarantee is a promise made by the bank to its clients to fulfil a contractual obligation.

This guarantee enables a firm to acquire items that it would not otherwise be able to, therefore assisting business growth and encouraging entrepreneurial activity.

Bank guarantee Example

Below is an example of bank guarantee for your understanding

Bank Guarantee Example 1

For example, “White Sip” is a newly formed tea business looking to acquire raw materials like green tea and flavoring agents worth Rs.1 Crore for production of their flavored tea. Before the raw material is delivered to “White Sip” company, the raw material seller wants a bank guarantee to cover payments inorder to process the business transaction.

The “White Sip” company applies and gets a guarantee from the lending institution or bank by keeping its cash accounts. To be precise, what happens is the bank basically cosigns the order contract with the vendor. If “White Sip” company defaults in payment, the vendor can recover it from the bank without worrying about it.

Bank Guarantee Example 2

A major Mobile Electronics maker, for example, might like to work with a small Mobile accessories vendor. Before engaging into a business deal for Rs.60 lakh worth of mobiles, the Mobile Electronics producer will ask the small seller to offer a bank guarantee.

The beneficiary in this scenario is the major Mobile Electronics maker who wants a guarantee before engaging into a deal. The major Mobile Electronics maker might claim damages from the bank if the small vendor is unable to provide the accessories as per the deal agreement.

Benefits of Bank Guarantees

For the applicant

Small Companies can get loans and conduct business in ways that they would not otherwise be able to. Due to the riskiness of the contract, it may not be possible It is the counterpart. It promotes business growth, and entrepreneurialism Activity

Bank guarantees are usually offered at a fraction of the total transaction and charge a low fee.

For  the beneficiary

With due diligence done on the counterparty, the beneficiary can sign the contract.

The bank guarantee increases creditworthiness for both the applicant as well as the contract.

The bank’s guarantee that they will pay the liabilities should the applicant default results in a reduction of risk.

The transaction is more secure overall.

Bank Guarantees: The downsides & Disadvantages

The participation of a bank might cause the procedure to be slowed considerably.

Add a layer of complexity and bureaucracy on top of it.

It occurs when When it comes to high-risk or high-value transactions, the bank is the greatest resource. It is possible that the applicant may be required to give assurance in the form of Collateral.

Types of Bank Guarantee

There are many types of bank guarantees provided by lending institutions. Direct guarantees are usually given by banking intuitions for local, national or foreign business transaction purposes. When the bank’s security is not dependent on the existence, legality, and enforce-ability of the primary obligation, it is referred to as a bank direct guarantee.

Direct guarantees are often chosen by individuals for cross-border and international business transactions. They can be easily adapted to foreign legal systems or practices as they don’t require form requirements.

Indirect guarantees are most common in export businesses, particularly when public agencies or entities are the beneficiaries. Because of legal requirements or other forms, many countries are reluctant to accept foreign banks and guarantors. An indirect guarantee is when one uses another bank, usually a foreign bank that has a head office in a beneficiary’s country.

When a government agency or another public organization is the subject of the guarantee, indirect guarantees are frequently given.

The following are the most frequent types of guarantees:

Shipping Bank Guarantee

A carrier is offered this type of guarantee if a package arrives before any documentation are received.


1. Loan Bank Guarantees

If a borrower defaults on a given loan, the financial institution or Bank that issued the guarantee promises to cover the financial obligation attached to it.

2. Advanced payment Bank Guarantee

This guarantee serves to back up the fulfillment of a executed contract.  This guarantee is essentially a kind of collateral used to refund an advance payment if the seller defaults to deliver the items promised in the contract.

3. Confirmed Payment Bank Guarantees

This is rather a fixed promise made by the Bank with this irrevocable assurance; the bank pays a certain sum to a beneficiary on the client’s behalf by a specific date.

4. Guarantee from Tender

This guarantee provides protection in the event that the company fails to fulfill its commitments to the tender organization or any other party specified in the order received as a result of winning the tender.

5. Guarantee in favor of customs officers

This assurance serves as a guarantee to the customs authorities that the firm carrying out import and export activities will pay the customs taxes and duties.

6. Guarantee that the warranty will be fulfilled

This assurance ensures that the terms of the contract are met in terms of quality.

7. Guarantee to Ensure Retention of Money

Retention money is a portion of the contract payment that is held back and paid out after the contract is completed successfully.

The purpose of a Retention Money Guarantee is to ensure that the beneficiary’s retention money is released to the applicant (contractor) so that he has enough operating capital to finish the contract.

What is Performance Bank Guarantee?

  • In a situation where a seller fails to satisfy delivery conditions or other contract obligations, a performance bank guarantee offers a solid assurance of reimbursement of a certain sum of money.
  • This type of assurance is intended to strengthen the contractual relationship between a seller and a customer especially in a tender.
  • In general, a bank guarantee is an irreversible obligation for the bank to pay a set monetary amount if the party represented by the bank fails to satisfy the contract’s conditions.
  • Most banks provide a variety of guarantees to their clients and the parties with whom they have gone into contracts.
  • One of these is the payment guarantee, which assures the seller that the buyer will meet all payment obligations as stipulated in the initial contract.
  • When contracts stipulate the fulfillment of an advance payment to the seller, an advance payment guarantee applies.
  • It also ensures that any advance payment will be returned to the customer if the seller fails to meet any of the seller’s commitments for services or commodities.
  • Participating in international tenders requires a tender guarantee, often known as a bid bond. One example would be covering organizers’ expenditures if one of the participants withdraws its bid or refuses to accept the established offer.

Sample Performance Bank Guarantee Format (International)

Date:___________

Beneficiary: [Name of the Company /Individual]

Address:

1234 Street, India

Performance Guarantee No.: 2021/001-PFMN/CNT

Dear Sir,

We have been informed that M/s. XYZ, (hereinafter called “the principal”), has entered into contract No. 2021/001-PFMN/CNT dated Day, Month, 2021 with you, for the supply of 2000 Metric Ton/Metric Tons of Aluminum Sheets.

Additionally we understand that, according to the conditions of contract, a performance guarantee is required.

At the request of “the principal”, we State Bank of India, branch XYZ. hereby irrevocably undertake to pay you any amount or sums not exceeding in total an amount of 200,000 U$ (Two Hundred Thousand U$) upon receipt by us of your first demand in writing and your written statement stating:

  • that the principal has failed to meet his responsibilities under the tender terms, as well as the regard with which he has failed.

The following papers must also be included to your payment demand:

The branch in the beneficiary’s country, or one of the corresponding banks in the beneficiary’s country, should produce and sign a proof of identification certificate confirming that the bank has validated the beneficiary’s signature(s) appearing on the first demand for payment.

This warranty will expire no later than Date-(Day, Month, Year.)

As a result, any payment demand made under it must be received by us at our office by that date.

The Uniform Rules for Demand Guarantees, ICC publication No. 758, govern this promise.

Bank Guarantee Charges

How do banks calculate fees for bank guarantee?

Bank Guarantee Charges and fees varies from bank to bank. Typically, banks charge 0.5–1% commission (100 percent Cash Margin)/2–3% in the case of against collateral, plus Bank Guarantee issuance charges and handling charges. Service taxes are also added to the amount.

The guarantee fee is collected by banks depending on the risk assumed by the guarantee.

Bank Guarantee Charges India

There are two different kinds of promises offered by Bank Guarantee.

The first is a financial guarantee, and the second is the guarantee’s performance. Financial Guarantee has a higher risk and is charged at 0.75 percent each quarter, whereas Performance Guarantee has a lower risk and is priced at 0.50% per quarter.

  • There will also be processing fees of about Rs300/- per lac (approx.).
  • Handling fees range from Rs.100 to Rs.150 each transaction.
  • The banks demand on security for the guaranteed amount.
  • Accepting a Term Deposit equal to the guaranteed amount can make this 100% safe.
  • A party may give collateral security in some cases.
  • Cash margin is also set at 25% of the guarantee amount.
  • The costs are lowered to one-fourth of the original amount if it is 100 percent secured (cash margin).
  • The warranty is for a minimum of 6 months to a maximum of 3 years.
  • It is sometimes permitted for up to ten years
  • In the event that the client has provided collateral security

Below are two examples to help you understand for international Bank Guarantee charges:-

  • If you require a $20000 Bank Guarantee for a year, you must pay a 20% cash margin (which will be refunded after the Guarantee term) of $4000, and you will be charged 0.75 percent every quarter, for a total of 3 percent.
  • You must pay 15% Tax on commission, which is $90, and you must pay $20000*3% = $600.
  • So, for a guarantee of $20000, the total cost will be $690.
  • If you don’t have any collateral security, you’ll have to pay $20000, plus $690 in fee and Taxes, which will be refunded after the guarantee term.

Note: These examples are based on assumptions for the institution and it may differ from one bank to the next.

Sample Bank Guarantee Charges SBI (State Bank of India) Click Here

Eligibility and Procedure for Bank Guarantee (BG)

  • Anyone with a solid credit history can apply for a Bank Guarantee (BG).
  • A firm can execute Bank Guarantee (BG) in its own bank or any other bank providing similar services.
  • The bank will verify the applicant’s past banking history, creditworthiness, Credit Score, liquidity, CRISIL and CIBIL ratings before granting the Bank Guarantee (BG)
  • For approval, the bank will additionally look at the Bank Guarantee (BG) period, amount, beneficiary information and currency.
  • Under certain circumstances, banks will ask the applicant to provide security or collateral to cover the BG amount.
  • Once all the conditions are fulfilled, the banking authorities will grant proper permission for the Bank process.

Documents Required for Bank Guarantee

  • Letter of request and counter indemnity note, as well as a memorandum of duty on a fixed deposit (FD) duly stamped (As per the respective State Stamp Act).
  • Signed Resolution of the Board of Directors of a Private Limited Company / Limited Company.
  • Printed Bank Guarantee Application Form of the specific Bank.
  • Order Copy or other Deal documents
  • The lien letter and the details thereof for which the bank/institution will provide the bank guarantee.
  • Nature and Features of Collateral Security: Your covering letter requesting the issuance of the bank guarantee, as well as a summary of the papers you have provided and the type of collateral security you are providing for the bank guarantee.

What is Bank Guarantee Letter?

A letter of guarantee or bank guarantee is a document given by your bank that guarantees payment to your supplier for the products or services provided to your company if your firm is unable to pay.

Your bank will pay your provider up to a certain amount in that scenario.

A letter of guarantee is not the same as a commercial letter of credit, which promises the bank to pay the supplier directly on your behalf when services are rendered, even if your firm has the financial means to pay or No.

When your suppliers are unsure of your ability to pay, your firm can obtain a letter of guarantee from your bank.

This can happen if:

  • Your business is dealing with a new supplier who refuses to provide a business credit (ie, allows the purchase of goods or services without immediate payment).
  • Your business is still in its infancy, and you do not have a sufficient credit history for the supplier to assess your ability to pay.
  • Your business is doing business with a vendor who is located outside of its regular business area or in another country.

To obtain a letter of guarantee for one of your vendors, your firm must submit an application to your bank in the same way it does for any other loan.

If your application is accepted, your bank effectively transfers its credit rating to your firm, making the supplier dependent on you for payment.

This makes purchasing items and services for your company more easier.

A letter of guarantee is sometimes referred to as an “additional loan” because it does not require the bank to pay any invoices to your company, as long as you can cover your costs. Companies pay an annual fee but do not pay any interest for this privilege.

A portion of the entire amount insured by letter is generally charged as a fee.

Letter of Credit vs Bank Guarantee-The difference

Letter of Credit

Because it functions as a bank guarantee from a bank or  financial institution, such as a bank or credit union, a letter of credit is also known as a “document of credit.”

  • This guarantees that the buyer pays the vendor on time or that the borrower pays the lender in full.
  • If the buyer is unable to pay, the bank will cover the entire outstanding amount.
  • A letter of credit is an agreement between a bank and a customer to pay a specific amount if certain conditions are met.
  • Once these criteria are satisfied and confirmed, the bank will transfer the money. Payment will be made for the duration of the services, as per the letter of credit. The letter of credit acts as a stand-in for the customer’s bank loan, ensuring prompt and accurate payment.
  • Consider the case of a distributor who receives a request from a Canadian customer. Since the wholesaler has no way of knowing whether the new customer will be able to pay his bills or not, it asks for a letter of credit to be included in the purchase contract.
  • The buyer asks for a letter of credit or line of credit (LOC) from a bank that has sufficient funds or a line of credit to finance the purchase.
  • The bank is the one who issues the letter of credit. It defers payment until the buyer certifies that the item has been delivered.
  • Once the goods are moved, the bank will pay the dues to the wholesaler.

It is assumed that the terms of the contract of sale have been fulfilled.

Types of letters of credit

Letters of credit, like bank guarantees, have their own set of rules.

The following are the most common letters of credit:

  • An irrevocable letter of credit ensures that the buyer will be obligated to the seller.
  • The letter of credit will be validated by another bank.
  • If the first letter is not creditable, it ensures that the second one will be paid.
  • The confirming bank guarantees payment if the issuing bank or corporation fails to meet its obligations.
  • Import letters of credit enable importers to get quick payments and cash advances.
  • If all requirements are met, a letter of credit exports informing the buyer’s bank that it must pay the seller.
  • customer specified
Letter of CreditLetter of Guarantee
Selling a product to a consumer is often a risky proposition. You are trusting your consumer to pay as promised without asking for cash or advance on delivery. When you ask for a letter of credit from your customer, he should go to a bank and get a letter from the bank stating that the bank will pay when you present the letter and proof of delivery. Because the payment comes from a third party bank rather than from the buyer, a letter of credit eliminates any financial risk for the seller.A letter of guarantee functions similar to a letter of credit, with the exception that it pays either party if the other fails to meet the criteria for the transaction. For example, if you make payment to your supplier before delivery of the goods and do not receive the same, and you have requested a letter of guarantee from the supplier before making payment, the bank will be liable for the goods not delivered to you. will have to return. If the shipper fails to show proof of delivery, the letter of guarantee allows you to claim compensation without going to court.

Bank Guarantee Invocation

Any reasonable claim must be honored by a bank during the guarantee’s validity term. If the invocation is valid and there is no court order preventing payment to the beneficiary, the bank is obligated to honor the payment.

Before making a payment to the beneficiary, the bank tells the applicant that the guarantee has been invoked and requests that he arrange for money to pay the claim amount.

Cancellation of Bank Guarantee

You can ask to have a letter of assurance that has been given to a beneficiary cancelled. When a letter of guarantee’s validity expires, it can be terminated.

The beneficiary must provide the original letter of guarantee and request that the bank cancel it in order to cancel the letter of guarantee.

You won’t be able to do anything else with the letter of guarantee after it’s been cancelled.

Bank Guarantee Cancellation Letter Format / Release Request Letter Format

[Date]

[Recipient Name]

[Bank Name]

[Recipient Address]

Subject: Back Guarantee Cancellation Letter

Dear [Recipient Name],

This letter is with reference to the bank guarantee number [012345678] that was given on [Specified date] under account number [0123456789].

I would like to ask the bank to cancel / release the above mentioned guarantee effective [specified date] and transfer the associated funds back to the [CC/my] account.

We appreciate your swift action on the matter. Enclosed with this letter are the bank guarantee details and other supporting document for your reference.

Thank you very much,

Sincerely,

Seal & signature

Bank Guarantee Reference Number: __________

Date of Issue: __________

Account Number: ________

Name of Beneficiary: __________

Beneficiary Account Number: _______

Thank you for your cooperation.

Important FAQ’s on Bank Guarantee

What are the various types of bank guarantees available?

There are many types of Bank Guarantees. Each one is for a specific type transaction.

  • Performance Guarantee
  • Financial Guarantee
  • Advance Payment Guarantee
  • Tender Bid Bond Guarantee
  • International Bank Guarantee
  • Deferred/Delayed payment Guarantee

What is the distinction between LC and BG?

The beneficiary of a Letter of Credit gets paid the money after the need to submit documentation is satisfied.

A Bank Guarantee, on the other hand, pays the beneficiary if the obligation is not met according to the BG’s contract.

What is the meaning of a bank guarantee?

A bank guarantee is a pledge made by a commercial bank to take responsibility for a debtor if he or she fails to satisfy contractual obligations.

A modest fee, often 0.5 to 1.5 percent of the entire contract value, is charged for bank guarantees.

How do you figure out the BG fees?

Fees are assessed on a quarterly basis and are determined by the kind of BG.

For the BG validity period, they might be based on the BG value of 0.75 percent or 0.50 percent.

In addition, the bank may levy a processing cost, paperwork fee, and handling fee.

Is it possible to get a return on a bank guarantee?

If a party fails to finish a project or activity, he or she will be compensated….

The vendor will guarantee that the goods or service will be delivered on schedule and in good working order.

What is the maximum Limit for Bank Guarantee (BG)?

The bank can issue BGs to applicants at any time, up to the sanctioned “BG Limit Amount.” The BG limits are considered “Non-Fund Based”.

What is the procedure for obtaining a bank guarantee?

A bank guarantee states that if the buyer fails to pay the seller or creditor the agreed-upon sum, the bank will pay the seller.

On the other hand, a letter of credit pays the seller when the buyer delivers.

What are the fees associated with bank guarantees?

A fee of 0.5 to 1.5 percent of the entire contract value is generally charged for bank guarantees.

Is it possible to revoke a bank guarantee?

Before or on the expiration of the guarantee, the beneficiary of the guarantee must activate the BG.

If the guarantee is not obtained or the original guarantee is not offered for cancellation within a reasonable period of time, the bank might cancel it.

Is it possible to obtain a bank guarantee for my property?

Secured Guarantee: A Secured Guarantee is a bank guarantee against assets, including cash margin.

It ensures that the bank will not issue any securities with a value lower than the contingent liabilities.

What is a bank guarantee’s validity?

Bank guarantees should be limited to ten years.

Banks can offer bank guarantees (BG) for periods longer than ten years, taking into account the impact of extremely long-term guarantees on their Asset Liability Management and their policy on providing guarantees for periods longer than ten years.

Is it preferable to eat LC or BG?

For banks, bank guarantees are a more important contractual duty than letters of credit.
A bank guarantee, like a letter of credit, assures a recipient of a certain amount of money.
The bank will only pay that amount if the other party fails to meet the contract’s requirements.

Is it possible to renew a bank guarantee?

Banks may include an appropriate clause in their bank guarantee that automatically extends the guarantee’s validity duration by 6 months, as well as acquire a suitable assurance from the client at the time of guarantee establishment to avoid any potential complications afterwards.

Is it possible to change a bank guarantee?

No, Bank Guarantee cannot be changed or amended.

If I have a savings account, is it possible to pick Bank Guarantee?

You can pick Bank Guarantee if you have a bank savings account.

Clients of ICICI Bank can also obtain Bank Guarantees for non-commercial purposes such as employment or college studies.

You must, however, submit your request in person at the branch.

Is it possible to apply for a Bank Guarantee online?

Yes, you may apply for a Bank Guarantee through the internet from your Bank..

Points to Keep in Mind When Using a Bank Guarantee

It ensures that both parties to a trade deal are financially secure.

Both the buyer and the seller are covered by the bank guarantee.

The seller is the one who benefits.

It can take many different shapes and kinds, depending on the demands of the trade agreement’s participants.

The bank serves as a third-party facilitator and solely ensures the financial payment obligation’s conditions.

Conclusion

A bank guarantee protects both parties in a commercial transaction financially.

To safeguard their financial interests, each party can issue several forms of bank guarantees.

It’s an effective instrument for facilitating international trade.

Online Bank Guarantee Application

ICICI Bank Guarantee Apply Online Click Here

Axis Bank Guarantee Apply Online Click Here

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