A bank guarantee refers to a promise provided by a bank or any other financial institution that if a certain borrower defaults on a loan, then the bank or the financial institution will take care of the losses on his behalf.
The guarantee is usually given on a contractual obligation between the bank and its customers.
The objective of such guarantee is to protect the third party from financial losses in business and personal transactions & to promote international and domestic trade.
Based on the type of the BG & the amount of risk involved , fees are generally charged on a quarterly basis on the BG value of 0.75% or 0.50% during the validity period.
FEATURES OF A VALID GUARANTEE
- The period of guarantee must be clearly specified
- The guarantee must be issued for a specific amount.
- The purpose of guarantee must be stated clearly.
- The grace period allowed to enforce guarantee rights is also stated clearly in the guarantee.
- The events under which it can be enforced must be stated clearly.
TYPES OF BANK GUARANTEES
The following are the different types of guarantees which can be given by a Bank –
- Financial Guarantee : In this type of guarantee, the bank undertakes to repay the debt owed to the seller on behalf of the buyer in case he fails to do so after charging a small initial fee at the time of issuance of guarantee.
- Performance Guarantee : These guarantees are issued for the performance of a contract or an obligation. In case, there is a default in the performance of the contract, the bank undertakes to make good the loss caused to the beneficiary.
- Advance Payment Guarantee : This guarantee assures that they would return the advance amount in case of no fulfillment of the terms.
- Bid Bond Guarantee : It is a type of construction bond that helps to safeguard the owner in a construction bidding process. This guarantee promises to compensate the owner in case the bidder fails to honour the terms.
- Payment / Loan Guarantee : The guarantee is for assuring the payment/loan repayment. In case, the party fails to do so, a guarantor has to pay on behalf of the defaulting borrower.
- Deferred Payment Guarantee : This guarantee is usually made for payments made in installments that are deferred or delayed & is used for the purchase of goods or machinery for business.
- Foreign Guarantee : This type of guarantee is generally issued for foreign beneficiaries.
- Shipping Guarantee : This type of guarantee is given to protect the shipping company from all kinds of losses in case the customer fails to repay. This document helps the customer to take possession of goods.
Thus, in simple words a Bank Guarantee is a guarantee from a financial institution like bank that it will fulfill the financial obligations of the buyer in case he fails to repay the loan amount to the seller.