A bank guarantee is a type of legal assurance whereby an issuing bank ensures the beneficiary that the liabilities of the buyer (applicant) will be fulfilled by the bank in case the buyer fails. To put it simply, in a BG, the guaranteeing bank performs due diligence on the behalf of its applicant and offers payment security to the beneficiary within specified terms & conditions under a contract.
Bank guarantee is one of the most used global trade finance instruments among importers & exporters to avoid the risk of payment. The issuing bank promises to reimburse the losses to the beneficiary in the event of the buyer’s default. The involvement of a legal third party ie. a Bank or a Financial Institution provides peace of mind to the beneficiary regarding an on-time payment while also establishing the buyer’s credibility to pay in foreign trade transactions.
A Bank guarantee is issued by a legal institution for a specific amount and a predetermined period by both the parties ie. seller and buyer. It eliminates the risk of non-payment & non-performance under a global trade transaction.
In this blog, we are explaining some of the major types of bank guarantees. Here they are as follows:
A performance guarantee is a type of bank guarantee where the bank or FI compensates the beneficiary in case of delayed predetermined performance. In simple words, a performance guarantee takes effect when the buyer has incurred costs and the seller hasn’t provided the ordered goods or services as mentioned in the contract. It is issued for securing a particular task and completion of the same in the prescribed period. The beneficiary can cover losses from the bank for default in delivering services on time.
As its name suggests, it is issued by a bank to provide a financial guarantee to the beneficiary against any default made by the buyer in payment. In other words, the bank takes the responsibility to pay the seller if the buyer is incapable of paying as per the T&C of a BG contract. Also known as payment default guarantee, it provides payment security to the seller for the delivered goods. It is one of the most used trade finance instruments that guarantee that if there is a delay in payment or no -payment at all, the bank will make the payment.
It is another frequently used trade finance instrument, issued by a bank to secure the advance amount/payment made by the buyer to the seller. In case if the seller is unable or defaults to deliver the goods or services for which he has been given an advance amount, the buyer can approach the bank under the payment guarantee contract and get the amount recovered from the seller. They are most commonly used in international trade & domestic transactions wherein huge advance payments are involved.
This type of bank guarantee is issued in tenders to ensure that the winning bidder has all capabilities to perform the contract as per the terms of the winning bid. In case the bidder is incapable of performing the contractual obligations, the tender issuer can avail the BG and forfeit the amount. It is conducted by the contractor for the owner of a project or any type of operation guaranteeing that the concerned bidder will execute the project as per the T&C. It provides a proof of guarantee to the owner of the project.
This is the type of bank guarantee where the one party in the transaction accepts to make the payment to the beneficiary at corresponding times in the future. In case if the debtor is unable to pay the amount in given periods, the beneficiary can use a deferred payment guarantee and claim the money. In simple words, it is a bank guarantee where the buyer is allowed to make the deferred payment to the beneficiary for a certain period. Here, the beneficiary provides the buyer with a credit period to make the payment in installments.
It is used in foreign trade transactions where the bank issues a foreign bank guarantee on behalf of a borrower to protect the foreign beneficiary.
This type of bank guarantee is issued to protect the shipping company against any default made by its customer.
1. A bank guarantee protects the beneficiary against a payment default made by its applicant by issuing a payment assurance under a BG contract.
2. Bank guarantees make it easier for the global importers & exporters to avoid international trade risks and engage in safe & secure business transactions.
3. It provides proof of the buyer’s creditworthiness to the seller.
These are some of the major types of bank guarantees. Figure out the concerned business requirements and approach a reputed bank with sound experience to avail the most suitable type of bank guarantee.