A bank guarantee is a type of guarantee from a lending institution. A bank guarantee means a lending institution takes care of the liabilities of the debtor. A bank guarantee is a kind of agreement between an individual and the bank, where the bank/ lending institution promises to cover the loss for defaults or debt to a third party.
A bank guarantee means the bank opens a written certificate to the beneficiary at the consignor’s request. A bank guarantee has the responsibility to handle debt or obligations instead of the consignor. The rights and obligations of both parties would be prescribed by the contract. If the consignor fails to perform contractual obligations, the beneficiary can claim compensation from the guarantor, according to the bank guarantee.
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Verification and Claims Involved in Bank Guarantee
Benefits of Bank Guarantee:
Listed below are some of the benefits of bank guarantee for government and private sectors:
Benefits of Bank Guarantee for Government:
- Provides access to capital markets as well as commercial banks.
- Reduces cost for private financing to affordable levels.
- Facilitates privatization and public private partnership.
- Increases the rate of private financing for key sectors like infrastructure.
- Reduces government risk exposure by passing commercial risk to the private sector.
Benefits for Private Sector:
- Reduces risk of private transactions in emerging countries.
- Mitigates risks that the private sector does not control.
- Opens new markets.
- Improves project sustainability
How to Apply for a Bank Guarantee?
Providing bank guarantee is a process where the beneficiary is verified and has to apply for it at the bank. Bank guarantees are not only given to businesses, but individuals can also apply. However, businesses do receive the vast majority of the guarantees. In most cases, bank guarantees are not too difficult to obtain. The process of applying for the bank guarantee is very simple and is not governed by strict regulations.
To obtain a bank guarantee, the entity must have a current account at the bank. That means he must be an existing customer of the bank. Bank guarantees can be issued by the bank through authorized dealers. To raise a request for a bank guarantee, the account holder must contact the bank and follow the procedures given below:
- The banks charge a guarantee fee for issuing guarantee to the individual/ entity.
- Before providing the bank guarantee, the banker will verify the individual vis-a-vis financial position and credit worthiness and may request collateral/ security.
- After the verification process the applicant submits the following documents:
- Request letter and counter indemnity along with a memorandum relating to charge over fixed deposit duly stamped.
- Bank guarantee text.
- Board resolution for private limited company/ limited company.
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The Beneficiary's Verification:
The bank verifies the applicant’s financial standing and credit worthiness before issuing the bank guarantee. As bank guarantee is commonly used between business entities, banks verify applicant’s eligibility. The guarantee mainly consists of the consignor, the beneficiary, the address and the responsibility, effective term, commitment of the bank, as well as the validity of the letter of guarantee, the laws regarding jurisdiction and so on. If the beneficiary spots anything wrong with the terms, he shall immediately request the bank to modify in order to reduce the risks and hidden dangers vis-à-vis the contract. The bank guarantee can be verified from the following aspects:
- The Bank: The bank which issues the bank guarantee must have worldwide recognition and should be internationally reputable. The guarantor bank must have an agent relation with the beneficiary’s transmitting or corresponding bank, so that the beneficiary can verify the signature to determine the validity of the guarantee.
- Effective Terms: The letter of credit comes into effect after it is issued, but in actual operations the beneficiary provides guarantees with effective terms. For example, advanced payment guarantee would become effective after receiving a written confirmation that the guarantor bank or the seller has received the buyer's advance payment. If the guarantee cannot take effect due to various reasons (for example, the seller has no written confirmation) after the buyer paying, and the seller cannot fulfil his contractual obligations to deliver the goods, then the buyer cannot ensure his interests by right of the guarantee, as thus, the guarantee will lose its significance of "responsibility". Therefore, when you receive the letter of guarantee with effective terms, you must verify the terms to make sure there is no risk.
- Responsibility and Commitment of the Bank: The guarantees issued by the bank must contain certain commitments of being “unconditional” and irrevocable”. In this case, the term unconditional means the beneficiary claims that the consignor has failed to deliver the shipment or fails to fulfil his contractual obligations and requires the guarantor bank to pay the agreed amount. In this scenario, the beneficiary must not provide any other certification, in addition, whatever the actual cause may be, the bank must immediately and unconditionally pay the amount guaranteed to the beneficiary.
- The validity: the bank issues bank guarantees to the beneficiary with certain validity norms. The validity of most of the bank guarantees is from the day it is issued to the day when the corresponding obligations are met. But, in case of international transactions, the geographical differences and time zones lead to jet lag. The beneficiary has no time to deal with relevant formalities vis-a-vis claims. Traditionally guarantees are governed by local laws where the guarantor’s bank is located.
Claims of the Beneficiary:
The beneficiary must furnish a written application to raise a request and provide specified invoices. The guarantor will verify the documents and then pay the sum if the documents are found to be authentic. The claim could be telegraphic or a letter claim. Telegraphic claim refers to a form of a telegram, while letter claim is sent through mail.
Bank Guarantee vs Letter of Credit:
- A bank guarantee is a financial instrument that is issued by the bank wherein the bank guarantees or assures the beneficiary that the obligations will be met by the guarantor bank and the payment will be made in case the actual customer fails to meet his/ her obligations. In this case the bank will pay on behalf of the customers who request for a bank guarantee. On the other hand, letters of credit refers to a promise or commitment in writing made by a bank or any other financial institution or corporation to a particular seller that payment will be made to the seller if the seller completes performing whatever is mentioned in the letter of credit. The bank will only make payments on behalf of the original buyer when there is documentary proof that the seller has completed the transactions accurately by delivering the right product or service on time.
- Under the bank guarantee, if the buyer is unable to make the payments to the seller or creditor, then the bank pays the fixed amount to the seller as the obligations of the contract are not met.
- Bank guarantees are competitively priced. The tenure of bank guarantee is usually high. As bank guarantees are issued by banks that have an international reputation, they are accepted across the World. Bank guarantees can be availed in most currencies as well as Indian Rupees. Hence they are very helpful in global transactions.
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