Bank Guarantee without Collateral

Types of Bank Guarantee

There are different types of bank guarantees, which are required by businesses. You may avail of the one that best suits your requirements. Some of the most popular types of bank guarantees are the following :

• Deferred payment guarantee: This type of deferred payment guarantee is the most common type of bank guarantee. Suppose, the buyer fails to pay within the duration that is agreed upon by both parties, the bank takes the liability of paying the seller for the goods/services. Under the deferred payment guarantee, the bank makes the payment to the seller in instalments in the event of non-payment by the buyer
• Financial guarantee: This type of financial guarantee is used in situations when a company promises to complete a project within a particular timeframe and receives funds for the same. The financial guarantee from a bank states that the money will be returned to the client if the company is not able to finish the project within the stipulated time frame.
• Advance payment guarantee: In this advance payment guarantee, the buyer makes an advance payment to the seller. However, this amount is refunded by the bank in case the seller fails to deliver the goods as per the contract terms.
• Foreign bank guarantee: Foreign bank guarantee is used in international trade deals. While most bank guarantees involve only one bank, a foreign bank guarantee may involve two banks– one from each country.
• Performance guarantee: Performance guarantee means that the bank will provide compensation to the buyer or recipient of the services if the goods/services are of inferior quality and don’t meet the standards that have been mutually agreed upon by both parties.
• Bid bond guarantee Bid bond guarantees: are used during the bidding process for a project. When any project is up for bidding, multiple contractors compete to win it. The company or the institution awarding the project asks for a bid bond guarantee from all the bidders. This guarantee means that if the bid is accepted, the contractor will take up the project and execute it as per the required standards. If a contractor is awarded the project but is unable to take it up, the guarantee is evoked by the company and the bank makes the payment. The amount of a bid bond guarantee is generally 5-10% of the estimated project cost

Advantages of a Bank Guarantee

• Bank guarantee is mostly issued against collaterals or securities. Hence they have marginal charges as compared to the other lending instruments.
• Obtaining a bank guarantee is simple and can be completed quickly. This proves useful to businesses that require urgent credit.
• For the seller, a bank guarantee substantially brings down the risk involved in trade and bridges the trust gap between both parties.
• Issuance of a bank guarantee to your name is proof of your good financial records and can be instrumental in establishing credibility and attracting more businesses.

A bank guarantee is an agreement between 3 different parties and these are :

• The applicant (the party that requests a bank guarantee from the bank and borrows from a creditor)
• The beneficiary (the party that receives the guarantee)
• The bank (the party that agrees to sign and assures payment in case the applicant fails to repay the loan)

Documents Required for a Bank Guarantee

If you hold a current account with a bank, you need to furnish the following documents to apply for a bank guarantee:-

• An application form
• A bank guarantee letter
• A Stamp paper
• A resolution passed by the board of members in case of a public/private limited company

How Does a Bank Guarantee Work?

Once the bank issues a bank guarantee, it is forwarded to the seller after which he/she proceeds to complete the trade without any upfront payment. The guarantee also defines the time within which the buyer has to pay the seller. Once that is done, the bank guarantee becomes null and void.
In the event of non-payment by the buyer within the stipulated time frame, the seller invokes the bank guarantee and the bank is liable to pay the seller.
We will explain this better with the help of an example.
Suppose ‘company X’ manufactures apparel and receives a huge order. However, they lack the adequate resources to purchase enough raw materials to fulfil this order due to the pending payments from the previous orders.
Now, there is a ‘company Y’ that sells the raw materials that ‘company X’ requires. However they are hesitant to do business without any upfront payment and cannot merely rely on ‘company X’s’ word. So, ‘company X’ decides to apply for a bank guarantee from a bank for the total amount of the trade. The bank, upon taking a look at ‘company X’s’ financials and collateral, approves the guarantee and provides it to ‘company Y.’
This bank guarantee issued to ‘company Y’ means that if the buyer, i.e. ‘company X’ is unable to complete the payment within the stipulated time frame as stated in the document, the bank that has issued the guarantee will pay the seller.
Once ‘Company Y’ receives the guarantee, it will proceed to complete the trade and supply the raw materials to ‘Company X’ who then begins manufacturing the goods for the order. At a later date, within the stipulated time frame, ‘company X’ makes the required payment directly to ‘company Y.’ The bank guarantee then becomes null and void.