Estimated reading time: 4 minutes
A Bank Guarantee is a way for companies to prove their creditworthiness. It promotes confidence in a transaction that will greatly encourage the process. It is a ‘promise’ to make payment to a third party under certain circumstances – such as the failure of obligations from the buyer.
In action, the Bank Guarantee is relatively simple. If for example, Company A is a relatively small construction company that needs £1million worth of equipment. The seller may request a guarantee of payment in order to feel more secure in producing/ shipping the goods. The Bank Guarantee eliminates the risk of payment-failure and encourages trade on a mass scale.
The Bank Guarantee enables companies to purchase goods from suppliers which, without it, could have denied the buyer due to the risk surrounding a transaction with no guarantee of payment.
Bank Guarantee History:
Guarantee stems from the Spanish word ‘garante’, in the 17th Century, meaning a ‘person giving something as security’.
Bank Guarantees on Businesses
A bank guarantee is a broad term and there are several types of bank guarantee that can help businesses.
As an example, a small client is dealing with a multinational company on a project. They might require some form of a promise to have the relevant financial backing to complete that project. A bank would conduct due diligence on the small company and would act as a ‘guarantor’ to the multinational company; ensuring that the small client will complete the project on certain terms.
A bank guarantee is a ‘surety bond’. This bond is often addressed to a larger institution by which the bank pledges (and contractually agrees) to pay an agreed amount under particular conditions.
Letters of Credit vs Guarantees
Although Letters of Credit and Bank guarantees are similar, as both revolve around instilling confidence in the transaction, they do have dividing elements. The main difference, however, is that an LC ensures that a transaction goes ahead, whereas a BG reduces any loss incurred if the transaction does not go ahead.
Benefits of bank guarantees
- A Bank Guarantee allows SME’s to provide current and potential suppliers reassurance they can meet their financial obligations.
- Bank Guarantees offer financial credibility, being backed by a large institution such as a bank.
- Because the BG can be paid in different currencies, terms of the contract can be negotiated upon worldwide.
Types of bank guarantees
- Advanced Payment Guarantee – typically ensures the performance of a commercial contract.
- Loan Guarantee – promises to assume the debt obligation of the borrower if they face default.
- Performance Guarantee – ensures the full and due performance of the contract in line with the original contract.
- Deferred Payment Guarantee – this is a promise for a payment which has been postponed.
- Shipping Guarantee – a written guarantee which shows joint liability. Furthermore, it will be presented by the importer to the carrier in the event of goods arriving before the documents.
- Trade Credit Guarantee – This covers the providers of a good/ service against the risk of non (or late) payment.
Obtaining a Bank Guarantee:
To access a Guarantee, applicants must demonstrate creditworthiness to their bank. The bank would normally look at previous trading history, recent accounts, credit history, and liquidity. The bank would need to know how long the bank guarantee is required, the amount, currency, and beneficiary details. This is generally speaking of course, different guarantees will require different documentation. Moreover, a bank might ask for some security over the guarantee (e.g. liquid assets such as property or equipment it holds, and maybe a personal or directors guarantee).
It is important to note that in most cases, the business will use the Bank that holds it’s assets as it is often quicker due to the bank knowing the financial nature of the business.
The actual process is as follows:
- The BG applicant enters into a contract with a supplier (beneficiary) and establishes a Bank guarantee is required.
- The applicant goes to their bank and requests they raise a guarantee in favor of the beneficiary (supplier).
- The issuing bank will notify the bank of the beneficiary through paper and digital form.
- Once the beneficiary bank receives this, it will advise it’s client. The client will then go ahead happy and secure with the transaction.
Want to find out more about how a Bank Guarantee could work for your business? If you’re looking for a funder or bank to provide some form of guarantee or act as a guarantor on behalf of your company to allow you to fulfil larger contracts, offer confidence to an end buyer and grow, get in touch with our team or fill out the form here.