Bank guarantee. If you’re an importer or exporter engaging in international commerce, entering into numerous trade transactions is your major business activity since it puts you in contact with new contract parties. You apply for a variety of trade financing instruments, including a Bank Guarantee, to prevent the related foreign risks of various laws and rules, non-payment, and non-fulfillment.
This article might help you understand what a bank guarantee is and how it works if you are a worldwide trader.
What Is A Bank Guarantee?
A bank guarantee or also known as BG is a legal document issued by a bank or a financial institution to assure exporters/sellers/suppliers that they would be paid on time if the applicant/importer/buyer fails to pay the amount or fulfill the terms & conditions mentioned in the contract. Here, the issuing bank or the financial institution acts as a guarantor for the exporter to pay him with the whole or remaining amount as the case may be.
In other words, a bank guarantee is a legal promise made by an issuing bank or a financial institution to the exporters on behalf of their applicants that in the event if the importers are at default, they would be paid on time with a full-fledged amount by the issuing bank. It assures the exporter that they will get their amount for the delivered goods & services to the importer.
Key Takeaways For Bank Guarantee:
1. In a bank guarantee, a bank guarantee service provider promises to cover the loss if an applicant defaults on the loan.
2. A bank guarantee is always issued for a specific amount.
3. The purpose of the guarantee is clearly stated.
4. They are valid only for a specifically defined period.
5. There are additional risks for the lender in BG service, so these loans are issued with greater costs or interest rates.
Using An Example To Help You Understand Bank Guarantee
An exporter named ABC Ltd signs a contract with an importer named XYZ Ltd and requests that a bank guarantee be issued to protect it from nonpayment. The importer asks his bank to offer a bank guarantee to the supplier on his behalf. If the applicant’s credit history and financial stability are acceptable, the issuing bank will issue a BG to the importer. If the importer fails to pay or comply with the terms and conditions of the BG contract, the supplier can now seek reimbursement from the issuing bank. If the importer is unable to pay, the bank assumes responsibility for paying the exporter.
Types of Bank Guarantee
A BG is granted for a specified sum and for a specific length of time, during which the bank’s guarantee applies to the contract. Let’s look at the many forms of bank guarantees. The following is a list of them:
1. Financial BG – When a bank or financial institution issues a financial bank guarantee, it assures exporters that the bank will meet the financial obligations of the BG contract if the importer fails to pay the exporter for their supplied services. When an importer’s financial commitment is necessary, these guarantees are usually given in return for security deposits. It implies that instead of depositing money, importers can pay exporters using a financial bank guarantee.
2. Performance BG – A performance bank guarantee is given by a bank or financial institution to ensure that the bank will meet the terms and conditions of the BG contract if the importer defaults. Simply said, if the required products or services are not delivered on time as specified in the contract, the bank will compensate the exporter. A buyer must present proof of performance in order to receive a performance guarantee.
3. Advance Payment Guarantee – An Advance Payment Guarantee is issued by the bank when the seller is paid with an advance amount. According to BG terms, if the seller is unable to deliver the goods or services to the buyer as mentioned in the contract, the buyer will be returned or recovered with the advance payment made to the seller.
4. Bid Bond Guarantee – A bid bond guarantee is provided to protect the owner’s interests when he invites bidders to bid on a construction project he is managing. This form of assurance assures the owner that the bidder will complete the contract according to the terms and conditions specified. In the event that the bidder fails, the bank will compensate the project’s owner.
5. Deferred Payment Guarantee -This type of guarantee is issued when there is a payment being paid in installments that are deferred or delayed such as the purchase of goods or machinery, etc. The buyer’s bank undertakes the payment risks for the seller.
6. Foreign BG – A Foreign bank guarantee is issued by a bank for a foreign beneficiary.
How To Obtain A BG?
Obtaining a bank guarantee shares the same procedure as other trade finance instruments do. Any person who maintains a good credit score and a financial record are eligible to apply for a bank guarantee service. Many banks and private financial institutions are offering a range of international trade finance instruments at the best prices.
1. Before releasing a BG on request, the bank will thoroughly evaluate the applicant’s previous banking history, creditworthiness, CRISIL score as well as CIBIL rating.
2.The bank would also analyze the related bank guarantee issuance details such as the BG period, its value, and currency along with the beneficiary details.
3. In some cases, the issuing bank may also require security to be provided by the applicant to cover the BG amount.
Once the issuing bank is satisfied with the information provided by the applicant, it will issue a BG in the favor of the exporter.
Documents Required For BG
As previously stated, when an applicant asks for a bank guarantee, they must go through a lengthy review procedure at a certain bank. There are specific papers that they must present in order to receive a bank guarantee. The following is a list of them:
1. A BG application form
2. Order copy of the request of BG made by the beneficiary
3. Lien letter
4. Collateral details
5. Associated documents listed with the collateral etc.
Price of a BG
The amount of money a BG service provider costs for an issue is usually determined by the level of risk they are willing to take on. A Financial BG, for example, involves more risks than a performance BG, therefore it is more expensive and has a larger charge. Fees are generally levied on the BG value every quarter, depending on the kind of BG. You may also be charged an application cost, paperwork fee, and handling fee, among other things.
Recommended read : Bank Guarantee FAQs
Benefits Of A BG
Here are the reasons which make bank guarantees one of the most important types of trade finance instruments for both importers & exporters. Here they are as follows:
1. Proof of Creditworthiness – Since a particular transaction in a bank guarantee is backed up with legal support, it reflects their sound financial stability to the suppliers.
2. Reduced Financial Risks – The increased numbers of defaults on the hands of the importer have given birth to the immense demand for a bank guarantee service. Sellers find it complex to deal with an unknown buyer residing overseas they are not familiar with. A bank guarantee addresses this issue by providing payment assurance to the suppliers.
3. Overseas Opportunities – A BG enables exporters to deal with unknown parties overseas without any stress due to the involvement of the guaranteeing bank. Hus, they can discover more global opportunities for their businesses without any payment threat.
4. Nominal Fees – Another benefit of applying for a bank guarantee is the small fee charged by the banks.
5. Lesser Documentation – There is lesser documentation in the issuance of a BG. It only includes information about the concerned parties, the transaction, and the financials of the applicant demanded by the banks.
If you are a global businessman and looking for a List of fraudulent bank guarantee service provider, keep this information in mind before applying for it. A BG is an effective type of payment guarantee trade finance instrument being used in international trade.
To find out more information surrounding these banking instruments, get in touch or contact Finance-opinions.com.