Bank Guarantees are one of the most versatile and widely used payment mechanisms in international business, covering contractual obligations and therefore providing a high level of security. Nevertheless many corporate customers may consider Bank Guarantees administratively cumbersome, and difficult to procure.
A bank guarantee is a promise from a bank or other lending institution that if a particular borrower defaults on a loan or obligation under a contractual agreement, the bank will will cover the loss. Note that a bank guarantee is not the same as a letter of credit. Please also note that one cannot “lease or borrow” a bank guarantee! – One needs to have sufficient funds or a credit line in place, enabling a bank to issue a bank guarantee.
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How Bank Guarantees (or SBLCs) work
Bank guarantees represent a more significant contractual obligation for banks than letters of credit do. A bank guarantee, like a letter of credit, guarantees a sum of money to a beneficiary. However, unlike a letter of credit, the sum is only paid if the opposing party does notfulfill the stipulated obligations under the contract. This can be used to essentially ensure a buyer or seller from loss or damage due to nonperformance by the other party in a contract.
Bank guarantees protect both parties in a contractual agreement from credit risk. For instance, a property developer and its construction company may enter into a contract to build a car park. Both parties may have to issue bank guarantees to prove their financial bona fides and capability. In a case where the construction company fails to deliver a planning permission within a specified time, the property developer would notify the bank, which then pays the company the amount specified in the bank guarantee.
Which Type of Letter-of-Credit is right for me?
Bank Guarantees and Standby-Letters-of Credit are still quite common in international business and cover a wider range of individual needs. So it doesn’t come as a surprise that various forms exist.