Bank Guarantee

A bank guarantee is a promise from a lending institution that ensures the bank will step up if a debtor can't cover a debt. Letters of credit are also financial promises on behalf of one party in a transaction and are especially significant in international trade

A bank guarantee is a promise from a financial institution that ensures the bank will step up if a debtor can't cover a debt. Bank guarantees represent a significant contractual obligation for banks. Basically a bank guarantee, like a letter of credit, guarantees a sum of money to a beneficiary. The bank only pays that amount if the opposing party does not fulfill the obligations outlined by the contract. The guarantee can be used to essentially insure a buyer or seller from loss or damage due to nonperformance by the other party in a contract. Bank guarantees are just like any other kind of financial instrument—they can take on a variety of different forms. For instance, direct guarantees are issued by banks in both domestic and foreign business. Indirect guarantees are commonly issued when the subject of the guarantee is a government agency or another public entity. The most common kinds of guarantees include: shipping guarantees, loan guarantees, advanced payment guarantees, confirmed payment guarantees.

A Bank Guarantee is an agreement between 3 parties specifically, the bank, the beneficiary, and the applicant. The beneficiary is the one who takes the guarantee. And the applicant is the party who pursues the bank guarantee from the bank. Bank Guarantees are a vital banking arrangement and it plays an important role in encouraging international and domestic business. It is a way for companies to prove their creditworthiness. It is a ‘promise’ to make payment to a third party under certain circumstances – such as the failure of obligations from the buyer. In the case of international BG, along with the 3 parties, there is also a “correspondent bank”. If a bank does not have a branch in some foreign country, it issues BG in that country through its “correspondent bank”. The bank does all the required due diligence, financial and business analysis before issuing the guarantee.