Bank Guarantee Overview
Although a Bank Guarantee seems very similar to a letter of credit, and there are similarities, they are very different instruments which are used for very different purposes. A letter of credit is used to ensure that a transaction proceeds as planned. A Bank Guarantee is used to mitigate losses if a transaction doesn’t go as planned.
A letter of credit is an obligation by a bank to make a payment once certain contractual criteria are met. Once the required terms are completed and confirmed, the bank will transfer the funds. The clear purpose is to ensure payment will be made as long as the services are performed.
Similarly, a Bank Guarantee is a financial instrument issued by a bank that guarantees that a stipulated sum will be paid to a beneficiary. However, unlike a letter of credit, the sum is only paid if the opposing party in the subject transaction does not fulfill the stipulated obligations under the contract. Thus, a Bank Guarantee essentially serves to insure a buyer or seller against losses or damage due to nonperformance of the other party to the transaction.
Use of Bank Guarantees
Bank Guarantees might be used when a buyer obtains goods from a seller but is then unable to pay the seller as agreed. The Bank Guarantee would pay the seller in the transaction a contractually agreed upon amount. Similarly, if a seller was unable to deliver the goods according to the terms of a contract, a Bank Guarantee would obligate the bank to pay the purchaser the contractually agreed-upon amount. Essentially, Bank Guarantees are a safety mechanism for the opposing party in the transaction.
Bank Guarantees are often used in trade financing when buyers and sellers are purchasing and selling goods to and from overseas customers with whom they have no established relationship, in which case a Bank Guarantee is designed to reduce the risk which is borne by each party to a transaction.
Benefits of Bank Guarantees
- Bank Guarantees give small businesses the ability to reassure the opposing parties to a contract that they have the ability to pay for and finance projects that would otherwise seem beyond their capacity
- Bank Guarantees provide financial credibility and creditworthiness backed by a bank
- Bank Guarantees can be used in virtually every market around the globe and in virtually every business sector
- Bank Guarantees give the parties to a transaction a great deal of flexibility in negotiating contract terms over geography and currency
Bank Guarantee Advisory Support
Global Trade Funding provides world-class advisory services to assist clients in the deal structuring of every transaction undertaken. This includes Bank Guarantee advisory support to structure and negotiate the terms of Bank Guarantees. See Advisory Services.