Nowadays many people face situations in their business, contracts, etc where for instance they want to expand, buy new techniques, deliver on a job, use some rental service facilities. Obtaining a bank guarantee has helped many execute contracts, expand businesses, and cover all other necessary issues. In this article, you will find out how bank guarantees help solve problems for people. First, what is a bank guarantee, how does it work and how can you obtain one. Find out in this article:
Bank guarantees are services offered by financial institutions that support a person and mostly businesses by vouching for their creditworthiness and ability to meet obligations stated in a contract. The bank guarantee is a promise or undertaking given by a bank on behalf of a client (such as a business owner) to pay a stated sum of money to another party (the beneficiary) if the client fails to carry out an obligation. This agreement must be backed by evidence and documents.
A Bank Guarantee can also be referred to as a promise made by a bank on behalf of its customer. The bank promises to be responsible for whatever financial loss is incurred in the course of the customer’s business engagement with the other party if the bank customer is unable to pay. In other words, if the debtor or client fails to settle a debt, the bank covers it. A bank guarantee thus enables the customer, or debtor, to acquire goods, buy equipment or draw down loans, and expand business activity. The extent of the bank’s involvement is defined before the activity begins. The bank’s liability can only be activated if the bank’s customer is unable or fails to fulfill its own part of the contract agreement.
Types of Bank guarantees
Bank Guarantee can be direct or indirect. A direct bank guarantee is the one issued by the bank in favour of its customer to facilitate business between the customer and its business partner
Indirect Bank Guarantee is issued in favour of another bank to provide financial confidence on a transaction. Bank Guarantees could act as disadvantages to the banks. The bank customer’s request for a bank guarantee goes through an approval process and tight security. Thus, the process may differ from one bank to another. However, cash security is the most common security acceptable for Bank Guarantees. Bank Guarantee is sometimes referred to as a bond.
Why and when do you need a Bank Guarantee?
There are various reasons for which one might need a bank guarantee, this includes:
- If you are a principal awarding a contract or a job, you can make use of a bank guarantee when you are in doubt of your contractor’s ability to deliver on a job. With a Bank Guarantee, you can delay payment till the job is completed to your satisfaction.
- You can make use of a bank guarantee when you as a principal is making payment in advance to a person to perform a job. A bank guarantee assures you that your advanced money is secured till you have value for your money or are satisfied with the job done.
- Obtain a bank guarantee when you are awarding a contract and you want to make sure that the successful bidder performs well on the job after the bidding process has been completed.
- You can obtain a bank guarantee when making orders for supplies and want to be sure that the exact goods you ordered is what will be delivered to you (in quality and quantity). A bank guarantee will give some comfort to the supplier till you confirm the supplies are what you ordered for.
How to Apply for a Bank Guarantee
Bank guarantees are not limited to only business owners, individuals can apply for a bank guarantee as well. However, businesses mostly receive the vast majority of guarantees. In most cases, bank guarantees are not particularly difficult to obtain.
To request a guarantee, the account holder contacts the bank and fills out an application form where you identify the amount needed for the guarantee and reasons for which you are applying for the guarantee.
A typical bank guarantee application stipulates a specific period of time for which the guarantee would be valid, special conditions for payment and details about the beneficiary.
Sometimes the bank requires collateral. This could be in the form of a pledge or agreement for assets, such as stocks, bonds, or cash accounts.
Types of Bank Guarantee
Advance Payment Guarantee
This is a form of bank guarantee issued by a bank to provide confidence to a principal that the money paid in advance on a job awarded to the bank customer will be used for the exact purpose for which the advance was made.
Performance Guarantee or Performance Bond
A Performance Guarantee is issued by a bank at the request of its customer at the instance of the principal who wants a form of guarantee that the contractor will perform on a job awarded to them. A performance guarantee gives comfort to its business partner that the bank customer will perform as expected on a job.
This form of Bank Guarantee has the longest tenure as it is for the total duration of the contracted period. It is mostly used in construction contracts.
Bid Guarantee or Bid Bond
Bid bond is requested by the principal who wants to award a contract to interested contractors. A bid bond acts as a form of assurance that the job will be executed once the contractor is eventually awarded the job.
It is often included as part of the contract bidding documents which must be supplied by the willing contractors. If the contractor who gets the job is eventually unable to execute it, the principal will crystallize the bid bond and ask the bank to compensate them for the inability of the contractor to execute the job.
Payment Guarantee or Comfort Letter
Payment Guarantee or comfort letter acts as a consolation issued by a bank on behalf of its customer and in favour of a third party. The comfort letter assures the third party that the bank will make payments on behalf of its customer after some conditions have been met. Such conditions can be delivery of goods in the right quality and quantity or successful completion of a job awarded.