What is the Meaning of Bank Guarantee?
A guarantee means giving something as security. A bank guarantee is when a bank offers surety and guarantees for different business obligation on behalf of their customers within certain regulations. It is generally a promise made by the bank to any third person to undertake the payment risk on behalf of its customers.
Bank guarantee is given on a contractual obligation between the bank and its customers. Such guarantees are widely used in business and personal transactions to protect the third party from financial losses.
What are the Uses of Bank Guarantee?
- When large companies purchases from small vendors, they generally require the vendors to provide guarantee certificate from banks before providing such business opportunities.
- Predominantly used in the purchase and sale of goods on credit basis, where the seller is assured of payment from the bank in case of default by the buyer.
- Helps in certifying the credibility of individuals, which in turn, enables them in obtaining loans and also assists in business activities.
Though there are lots of uses from a bank guarantee for the applicant, the bank should process the same only after ensuring the financial stability of the applicant/business. The risk involved in providing such a guarantee must be analysed thoroughly by the bank.
What are the Advantages and Disadvantages of Bank Guarantees?
Bank guarantee has its own advantages and disadvantages. The advantages are:
- Bank guarantee reduces the financial risk involved in the business transaction.
- Due to low risk, it encourages the seller/beneficiaries to expand their business on a credit basis.
- Banks generally charge low fees for guarantees, which is beneficial to even small-scale business.
- When banks analyse and certify the financial stability of the business, its credibility increases and this, in turn, increase business opportunities.
- Mostly, the guarantee requires fewer documents and is processed quickly by the banks (if all the documents are submitted).
On the flip side, there are some disadvantages such as:
- Sometimes, the banks are so rigid in assessing the financial position of the business. This makes the process complicated and time-consuming.
- With the strict assessment of banks, it is very difficult to obtain a bank guarantee by loss-making entities.
- For certain guarantees involving high-value or high-risk transactions, banks will require collateral security to process the guarantee.
What are the Types of Bank Guarantee?
There are two major types of bank guarantee used in businesses, which are as follows:
- Financial Guarantee – These guarantees are generally issued in lieu of security deposits. Some contracts may require a financial commitment from the buyer such as a security deposit. In such cases, instead of depositing the money, the buyer can provide the seller with a financial bank guarantee using which the seller can be compensated in case of any loss.
- Performance Guarantee – These guarantees are issued for the performance of a contract or an obligation. In case, there is a default in the performance, non-performance or short performance of a contract, the beneficiary’s loss will be made good by the bank. For example, A enters into a contract with B for completion of a certain project and the contract is supported by a bank guarantee. If A does not complete the project on time and does not compensate B for the loss, B can claim the loss from the bank with the bank guarantee provided.
Bank Guarantee (BG) Eligibility and Process
Any person who has a good financial record is eligible to apply for BG. BG can be applied by a business in his bank or any other bank offering such services. Before approving the BG, the bank will analyse the previous banking history, creditworthiness, liquidity, CRISIL, and CIBIL rating of the applicant.
The bank would also examine the BG period, value, beneficiary details, and currency as required for the approval. In certain cases, banks will require security to be provided by the applicant to cover the BG value. Once the banking officials are satisfied with all the criteria, they will provide the necessary approvals required for the BG processing.
