Find out the basic information you need to know for bank guarantees, including the different types, characteristics, issuing, and receiving.
What Is a Bank Guarantee?
A bank guarantee, also referred to as a letter of guarantee, is a binding obligation by the issuing bank to pay the beneficiary – should the applicant fail to honour their financial and contractual obligations.
A Bank Guarantee can be issued in two different ways:
The issuing bank, under instructions from their client (the provider), issues a bank guarantee direct to another bank (the receiving bank). This can be for the account of the beneficiary, or in some cases, direct to the beneficiary themselves.
The providers bank requests their correspondent bank to issue a bank guarantee on their behalf. The correspondent bank becomes the issuing bank and will issue the bank guarantee – even though they do not hold the account of the provider.
Where a Bank Guarantee is being utilised for monetisation, it is considered to be a Demand Bank Guarantee. This type of guarantee has specific verbiage and is governed by ICC Uniform Rules for Demand Bank Guarantees (URDG 758).
Bank Guarantees are issued for varying purposes, such as payment guarantees for customs and shipping guarantees. Therefore, each different Bank Guarantee will follow an exact format relating to their specific purpose. For further information on the different types of Bank Guarantees, see below…
Types of Bank Guarantees
The issuing bank on behalf of their client (the provider), issues varying types of bank guarantees which fall into two classifications.
Performance Guarantee – Covers losses of the beneficiary in the event the provider is found guilty of non-performance on a contract.
Financial Guarantee – Promise to pay by the issuing bank should the provider default on a payment to the beneficiary.
The list of Bank Guarantees is outlined below:
Guarantee of PaymentContract Execution GuaranteeTender GuaranteeWarranty Execution GuaranteeCustoms GuaranteeAdvance Payment Guarantee
Characteristics of a Bank Guarantee
Issuing a Bank Guarantee
Any company can apply to their bank to issue a Bank Guarantee on their behalf. The bank will look for 100% security before issuing a Bank Guarantee and this can take the form of cash or assets. If the client is credit worthy the Bank Guarantee can be issued on margin.
The usual application forms will have to be filled out. Giving details of; currency, amount, expiry date and the name of the Beneficiary, along with the reasons for applying and if for a project, the requisite business plan must be supplied.
If the Issuing Bank agrees to issue a Bank Guarantee the mechanics of transferring the Bank Guarantee to the Beneficiaries account is straightforward. Utilising the swift system, (“Society for Worldwide Interbank Financial Telecommunications”), the bank will transfer the Bank Guarantee to the Beneficiary’s bank, using the dedicated message code for transferring Bank Guarantees, Swift MT 760. In some instances, The Issuing Bank will send a pre advice to the Receiving Bank, using the Swift Message Code MT 799 informing them to expect a Bank Guarantee in favour of their client.
Receiving a Bank Guarantee
If the Receiving Bank has received a swift MT 799 pre-advice, informing them that a Bank Guarantee is about be transferred, they will advise the beneficiary. Upon actual receipt of the MT 760, the bank will credit a separate account in the beneficiaries’ name, usually an electronic safe custody or keeping account. The Beneficiary will then receive a print-out of the swift message as proof of receipt.
The client or Beneficiary is now free to use the Bank Guarantee for the intended purpose and if being utilised for monetisation, the LTV (Loan to Value), will need to have already been previously agreed with their bankers.
It is important to note, if a company intends to enter into a contract where they will receive a Bank Guarantee, they must bank with an internationally acceptable institution that is part of the swift system.