Bank guarantee comes in place of a debtor in case he/she is unable to make payments to the creditors. Bank would perform the duties of a debtor for a commission, which varies between 0.5-1.5% of the guaranteed amount. It has become a necessity to obtain a guarantee when the transactions are huge and instead of going for any 3rd party, the bank becomes an easy way out.
The parties involved are
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Documents Required to apply for a bank guarantee are
- Request Letter and Counter Indemnity cum Memorandum relating to charge over fixed deposit duly stamped (Franking as per respective State Stamp Act).
- Bank Guarantee text.
- Board Resolution for Private Limited Company/Limited Company.
- First, the applicant will apply for a loan from the beneficiary or a creditor.
- These 2 parties have to comply to apply for bank guarantee
- The applicant needs to apply to the bank to provide a guarantee for the loan taken from the creditor.
- The bank will now provide the bank guarantee and provide financial instructions to the advising bank
Types of bank guarantee
There are 6 types of bank guarantee as of now. These are
Performance guarantee is issued when there are buyer and seller involved. It is needed when the buyer has made the payment but the seller is unable to deliver on time. The contract between the buyer and seller is invoked and now the buyer needs to put the necessary details in writing.
Bid bond guarantee
Bid bond guarantee is used in tenders and the winner bid undertakes a task. If the bidder is unable to fulfill his/her duties, then Bid bond guarantee is invoked. This would ensure partial/full forfeiture of the amount.
Financial guarantee ensures that in case of a project/service provided by a person/group of people, the project should be completed on time. In the case of incompetence, the bank would ensure the payment
Advance payment guarantee
In advance payment guarantee, the buyer has already made payments. But the seller is unable to deliver product/provide service in time. In this case, the bank would ensure the partial/complete repayment to the buyer. It is used in international/domestic business transactions.
Foreign bank guarantee
As the name suggests, this is done by a foreign bank to ensure the interest of the foreign beneficiary. This is done to ease the carry out of business internationally.
Deferred payment guarantee
This type of guarantee ensures a fixed amount to be paid in the future, in case of insolvency. The fixed amount is decided at the beginning of the contract and this could be claimed when the debtor is unable to pay the money.
- Bank guarantee is drawn by an account holder, where he/she orders his/her bank to contact the bank of the other party.
- Assets will be held by the bank as a security
- Bank Guarantees are non-transferable.
- Nobody has the right to sell/purchase it.
- CUSIP or ISIN numbers are not present in these guarantees.
- These are issued for a specific period of time.
- These guarantees terminate once they got expired.
- The end value of such guarantees is nil. There is no maturity value and investment element.
- There is a huge difference between bank guarantees and ‘investment notes’.
- This service is not provided to raise money by banks and so should not be confused with Medium Term Notes (MTN).
- These guarantees are as strong as the bank issuing them.
Difference between bank guarantee and letter of credit
There is a massive difference between a bank guarantee and letter of credit
- A bank guarantee is a financial or commercial instrument provided by the bank to assure payment or guarantee to the bank, in case of incompetence. The bank pays on behalf of the customer.
- Whereas, in the case of a letter of credit, a bank/financial institution/corporation promises to make payment to the seller, once the seller completes performing what is mentioned in the letter of credit. There needs to be a written document as proof to the seller to proceed with the process of delivering the right product/service on time. Then the seller is assured that the bank will definitely pay the amount.
- In the case of a bank guarantee, the buyer is unable to make payments to the seller or creditor and so the bank pays the fixed amount to the seller. Whereas, in the letter of credit, the bank becomes liable to pay to the seller, once the seller delivers the product on time.
- Furthermore, those whose business is to deal in export/import usually go for a letter of credit, to ensure payment once the seller completes his/her duties. But, in the construction business, bank guarantees work as a preferred alternative.
- Last but not least, the bank guarantees are costlier than its counterpart, since it provides security to both parties (buyer/seller or creditor/debtor) and it covers a wide range of services. Also, the amount involved in bank guarantees is usually huge.
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