Bank Guarantee
Grow your business by providing your suppliers and vendors with certainty of payment.
A Bank Guarantee is an alternative to providing a deposit or bond directly to a supplier or vendor. It is an unconditional undertaking given by the bank, on behalf of our customer, to pay the recipient of the guarantee the amount of the guarantee on written demand.
Bank Guarantees require security in the form of cash held on deposit with the bank, or real estate of a type and value acceptable to the bank.
A bank guarantee enables the customer (debtor) to acquire goods, buy equipment, or draw down loans, and thereby expand business activity.
What it is:
A bank guarantee is a promise from a bank or other lending institution that if a particular borrower defaults on a loan, the bank will cover the loss. Note that a bank guarantee is not the same as a letter of credit.
How it works (Example):
Let’s assume Company XYZ is a small, relatively unknown restaurant company that would like to purchase $3 million of kitchen equipment. The equipment vendor may require Company XYZ to provide a bank guarantee in order to feel more confident that it will receive payment for the equipment it ships to Company XYZ.
To obtain this bank guarantee, Company XYZ requests one from its preferred lender (usually the bank with which it keeps its cash accounts). The lender provides the guarantee in writing, which is then passed on to Company XYZ and its vendor. Company XYZ’s lender essentially becomes a co-signer on the purchase contract with the vendor.
Why it Matters:
A bank guarantee enables companies to make purchases that they would otherwise not be able to make; these guarantees thus serve to heighten business activity and expand entrepreneurial activity.
What’s the difference between a bank guarantee and a letter of credit?
A bank guarantee and a letter of credit are similar in many ways but they’re two different things. Letters of credit ensure that a transaction proceeds as planned, while bank guarantees reduce the loss if the transaction doesn’t go as planned.
A letter of credit is an obligation taken on by a bank to make a payment once certain criteria are met. Once these terms are completed and confirmed, the bank will transfer the funds. This ensures the payment will be made as long as the services are performed.
A bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary. Unlike a line of credit, the sum is only paid if the opposing party does not fulfil the stipulated obligations under the contract. This can be used to essentially insure a buyer or seller from loss or damage due to non-performance by the other party in a contract.
For example a letter of credit could be used in the delivery of goods or the completion of a service. The seller may request that the buyer obtain a letter of credit before the transaction occurs. The buyer would purchase this letter of credit from a bank and forward it to the seller’s bank. This letter would substitute the bank’s credit for that of its client, ensuring correct and timely payment.
A bank guarantee might be used when a buyer obtains goods from a seller then runs into cash flow difficulties and can’t pay the seller. The bank guarantee would pay an agreed-upon sum to the seller. Similarly, if the supplier was unable to provide the goods, the bank would then pay the purchaser the agreed-upon sum. Essentially, the bank guarantee acts as a safety measure for the opposing party in the transaction.
These financial instruments are often used in trade financing when suppliers, or vendors, are purchasing and selling goods to and from overseas customers with whom they don’t have established business relationships. The instruments are designed to reduce the risk taken by each party.
