Bank Guarante
A bank guarantee is a promise from a bank or financial institution to honour the obligations of a customer if they are unable to fulfil them. The guarantee essentially serves as a way for the customer to acquire credit from a third party, such as a supplier or potential buyer, by providing assurance that the debt owed will be repaid.
Typically, a bank guarantee is used in commercial transactions, for example when a supplier requires a guarantee to assure payment for goods/services delivered, or when a buyer requires a guarantee so that the buyer can return the goods in the event that they do not meet the agreed criteria or warranty.
In simple terms, a bank guarantee is a document that states a bank is held accountable for any losses suffered by a customer if certain conditions are not met.
Bank guarantees are also seen in situations such as bidding for a contract, where the successful bidder must provide an assurance that they can meet their financial obligations under the contract.
A bank guarantee can come in different forms and each of them serves a specific purpose. Common bank guarantees include:
• Performance Bonds - guarantees made by a bank to fulfill a contractual obligation if there is a breach of contract by the party undertaking the work.
• Payment Bond - guarantees made by a bank that a buyer will make payment if the supplier meets its obligations.
• Bid Bond – guarantees that the bidder on a particular contract will fulfill the agreed upon terms in the event that the bid is accepted.
• Advance Payment Bond – issued against advance payments for goods or services.
When a bank guarantees an obligation, it must honour the obligation even if the customer is unable to do so. This is known as thebank’s “absolute liability” and means the bank is liable for all losses suffered by the third party should the customer fail to meet its obligations.
The bank may need to cover the full amount of the third party’s claims or may only cover a portion of it. Generally, the bank has a legal responsibility to honour the guarantee, but there may also be restrictions or other specific conditions that must be met for the guarantee to be valid.
It’s important to note that a bank guarantee is different from a loan or a line of credit, in that the bank only needs to step in and honour the guarantee if and when the customer fails to do so.
While a bank guarantee can be a valuable asset for any business, it can also be a costly one. In consideration of providing the guarantee, the bank may require a fee for the service or charge a premium for the risk it is taking. This fee/premium is payable upfront and should be taken into account before issuing a bank guarantee.
At the end of the day, it is important to understand that a bank guarantee serves as an assurance of payment completion, rather than being a source of funds; and it is up to the customer to make sure that they have the required funds to honour their obligations without assistance if the guarantee is invoked.
