Bank Guarantee: Complete Process and its Types

A Bank Guarantee is a promise from a bank or NBFC to repay a customer’s debt if the customer defaults on its obligations. This type of guarantee can be useful for businesses that need to borrow money or obtain lines of credit. By providing it, the bank can help reduce the risk for the lender and make the loan more likely to be approved.

The Process of Bank Guarantee

It play a vital role in the banking system and are used to facilitate commerce and protect businesses from financial loss. Taking this is typically a fairly straightforward process. However, it is important to ensure that all necessary documentation is in order before proceeding. Additionally, it is important to be aware of the terms and conditions of its to avoid any surprises down the road.

Simply put, when an applicant applies for a loan from a beneficiary or a creditor, the creditor might ask for its. The applicant will request that a bank guarantee the creditor’s loan. The advising bank will receive financial instruction from the applicant’s bank and issue a bank guarantee.

For example, a construction company may borrow to build a new office building. The bank may require the company to provide a bank guarantee as collateral for the loan. If the company cannot repay the loan, the bank can draw on the guarantee to cover the loss.

Eligibility Criteria

 For a bank to issue a guarantee, the customer must first meet certain eligibility criteria. The most common criterion is that the customer must have a good credit history with the bank. Other criteria may include the customer having a certain amount of money in their account or having a certain type of account with the bank. Furthermore, before providing the customer with it, the bank will scrutinize the applicant’s creditworthiness, liquidity, and CIBIL score. The bank will also analyse the details of the beneficiary or the creditor.

Types of Bank Guarantees

Large banks typically issue bank guarantees with strong credit ratings. This provides assurance to the beneficiary that it will be able to collect on the guarantee if needed. There are two types: financial and performance. On-demand guarantees are typically used for financing transactions, while performance guarantees are used for construction contracts and other agreements.

Financial Guarantee

A financial bank guarantee is typically a letter of credit or a line of credit. The purpose of the guarantee is to provide the party with assurances that the financial institution will meet its financial obligations. Payment will be made to the bank if there is a lapse in the completion of the project, according to the financial guarantee agreement.

Performance Guarantee

On the other hand, a performance bank guarantee is conditional on the obligor breaching its obligations under the contract. The guarantee is typically issued in favour of the project owner and is designed to protect the owner if the contractor fails to perform its obligations under the contract. The performance bank guarantee typically pays a specified sum of money to the project owner if the contractor fails to perform its obligations.

Comparison between Bank Guarantee and Letter of Credit

There are several key differences between both. It is a promise from a bank to cover any losses that a customer may incur if they default on a contract. On the other hand, a financial institution’s letter of credit is a document that guarantees a seller’s payment for a certain amount of money.

One of the key differences between both is the amount of money involved. A bank guarantee typically involves a large amount of money, while a letter of credit typically involves a smaller amount. This is because a bank guarantee is a promise from the bank to cover any losses that the customer may incur, while a letter of credit is a document that guarantees payment to a third party.

Additionally, these are typically issued for a specific amount of money, while letters of credit are typically issued for specific goods or services. Finally, these are typically issued for a specific period of time. In contrast, letters of credit are typically issued for a specific period or until the goods or services have been delivered.

Advantages

It is useful for borrowers looking to secure financing for their businesses. They can also help to lower the interest rates on loans and provide peace of mind to both the borrower and the lender. There are several advantages of bank guarantees:

• First, they can help to secure financing for a borrower who might otherwise be unable to obtain a loan.
• Second, they can help to lower the interest rate on a loan since the lender knows that the bank is standing behind the borrower.
• Third, they can provide peace of mind to both the borrower and the lender since the bank guarantee means that the lender will not have to worry about the borrower defaulting on the loan.

Disadvantages

It is a type of financial guarantee that a bank provides to a borrower. The primary purpose is to protect the borrower if the borrower cannot repay a debt. However, there are some below disadvantages

• First, the bank may charge a fee for providing the guarantee.
• Second, the bank may require the borrower to maintain a certain level of collateral to qualify for the guarantee.
• Finally, if the borrower defaults on the loan, the bank may be required to pay the lender the full amount, which could put the bank at risk of financial difficulties.

Collateral Requirements

To obtain this, the customer must first provide collateral to the bank. Collateral is an asset or property that can be used to secure a loan or other financial obligation. The bank holds the collateral as security for the loan or obligation. If the customer defaults on the loan or obligation, the bank can seize and sell the collateral to repay the debt.

Common types of collateral include real estate, vehicles, jewellery, fixed deposits, and stocks and bonds. The value of the collateral must be equal to or greater than the value of the loan or obligation. The bank may require the customer to provide additional collateral if the value of the collateral decreases.

Frequently Asked Questions