Bank Guarantees
A bank guarantee or BG is a pledge by a bank to make good on someone’s debt in the event that he or she cannot pay it. Bank guarantees are similar to the bank standing as a cosigner on a transaction; in the event that the original party cannot follow through, the bank can be called upon to provide the payment to complete the transaction. Many banks provide bank guarantees as a service to their clients for the purpose of facilitating large business transactions and deals. This particular banking tool is primarily used by large clients such as MNC’s and governments.
From the perspective of a seller in such transactions, a bank guarantee provides security. It means that if the buyer takes possession and fails to pay, the seller can still recover the payment from the buyer’s bank. Bank guarantees may be used in situations where large amounts of financing are needed and it is not possible to obtain a loan from one Bank.
In a direct guarantee, a bank directly guarantees someone, usually for set terms such as amount and timeframe. The direct guarantee may also be generated for a specific transaction. Indirect guarantees are issued by one bank on behalf of a different banks customer, as for example when a foreign bank stands surety for someone by arrangement through that person’s domestic and primary bank.
These guarantees are not free of charge. Before a bank guarantee will be issued, the bank conducts a thorough investigation due to the high risk involved. Banks have no interest in taking on obligations and debts which they will probably be held responsible for. Due to the nature of a BG, people who are serious credit risks cannot qualify or obtain a bank guarantee. Banks also pay for this service. Fees vary depending on the bank and may be based on a percentage of the overall amount being guaranteed.
A Bank Guarantee or Banker’s Guarantee (BG) is a banking arrangement where a bank agrees to substitute its own credit in place of its client.
Different from a traditional Line of Credit (which is intended to be paid) a Bank Guarantee is a contingent obligation. We say contingent meaning that it is dependent on the happening of an event, which may or may not actually ever occur. More often than not a BG is not paid because the event, project or deal does not happen, i.e. the deal never goes through or the project never gets off the ground.
Everyday, banks of all sizes around the world, issue Bank Guarantees (BG) on behalf of their clients for a vast array of different purposes. A BG (Bank Guarantee) is never issued for the bank itself as it is always on behalf of its clients, and the full liability lies with the client.
The most common type of BG is performance-related. This is where a bank tells the beneficiary if the client does not follow through on certain requirements, the bank will step in and pay. A common example is a bank guarantee issued to a shipping company for the release of goods without the Bills of Lading (BOL). Another common use is as a substitute for cash payment. For instance BG may be issued to a utilities company to guarantee an account in lieu of a cash deposit, or in lieu of a cash deposit to support a tender.
There are also less common Bank Guarantees (BG) issued for financial reasons. A common example of this would be when an international corporation in one country desires to borrow from a bank for its subsidiary in different country. The corporation can ask their bank to issue a Bank Guarantee to the subsidiary’s bank guaranteeing the loan. The BG would then only be paid if the client were to default
Government Sectors
- Increases the rate of private financing for key sectors such as infrastructure.
- Provides access to capital markets as well as commercial banks.
- Reduces cost of private financing to affordable levels.
- Facilitates privatizations and public private partnerships.
- Reduces government risk exposure by passing commercial risk to the private sector.
Private Sectors
- Reduces risk of private transactions in emerging countries.
- Mitigates risks that the private sector does not control.
- Opens new markets.
- Improves project sustainability.