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A bank guarantee is a promise from a bank or other lending institution that if a particular borrower defaults on a loan, the bank will cover the loss.

How Bank Guarantee works

It helps to have a third party's vetting for your business.
When running a business, you might come across a situation that your client may ask you to provide a financial guarantee from a third party.

In such circumstances, approach your bank and ask it to stand as a guarantor on your behalf. This concept is known as bank guarantee (BG).

This is usually seen when a small company is dealing with much larger entity or even a government across border. Let us take an example of a company XYZ bags a project from, say, the Government of Ethiopia to build 200 power transmission towers

In this case, companies all over the world would have applied. The selection would be made on the basis of lowest cost and track record as submitted in the proposal form.

However, the government has limited ability to assess all companies for financial stability and credit worthiness.

To ensure the project is done satisfactorily and on time, the government puts a condition that company XYZ will have to furnish a guarantee given by one or more banks.

In banking nomenclature, company XYZ is an applicant, its bank is the issuing bank and the Government of Ethiopia is the beneficiary.

Usually, the BG is for a specified amount, which is a percentage of the total money required for the contract.

Obviously, the bank will not just issue such guarantee with its own due diligence. The bank does its own thorough analysis of the financial well-being of company XYZ to assess the amount of guarantee it can issue. After all, the bank is at a risk too, in case the client defaults. This amount is called a limit.

Here too there is a catch. The bank will issue guarantee provided the company has not exceeded its overall limit for BGs. And if the Government of Ethiopia is not satisfied with the performance of the contract at a later date, it can invoke the BG.

In this situation, the bank will have to immediately release the amount of the BG to the government. BGs can be broadly classified into Performance and Financial BGs. As the name suggests, Performance BGs are the ones by which the issuing bank, also known as the Guarantor, guarantees the ability of the applicant to perform a contract, to the satisfaction of the beneficiary.

Variations
Let us continue with our earlier example, to understand the different types of performance BGs. XYZ might need to give a BG that guarantees it has the capability to do the project, on winning the bid. This ensures only serious bidders are in the fray for the project. This is called a bid-bond guarantee. XYZ also might be getting an advance payment for buying materials, etc. Again, it will have to furnish a BG to the extent of the advance, called an advance payment BG. To secure the project even further, the Government of Ethiopia might insist on stage payment guarantees. This would have milestones like 20 per cent, 40 per cent, etc and a period in which these have to be done. As and when XYZ does that part of the work, the BG would expire, thus freeing its limits with the bank (banks also charge for these services, typically as a small percentage of the BG amount, even as little as 0.05 per cent).

Another interesting use of the performance BG is in importing materials into the country. In this case, an importer might want to contest the amount of duty levied by the customs and until the duties are paid, the goods are not released. The importer can, in this case, present a BG for the amount of the duty (also known as customs guarantee) and get his goods released. Once the final decision is taken, the import duty is paid and the BG released.

The other broader types of BGs are financial guarantees. These are used to secure a financial commitment such as a loan, a security deposit, etc. For example, guarantees of margin money for stock exchanges. These are issued on behalf of brokers, in lieu of the security deposit that needs to be paid at the time of becoming a member of the exchange.

The applicant, XYZ, has to prove credit worthiness only to one party, his bank, and can bid for projects across the world. The beneficiary, Government of Ethiopia, does not have to analyse how financially sound the companies are and knows that in case something goes wrong, the bank will pay him.

CLEAN TECHNOLOGY AND RENEWABLES

For any business, funding has a vital role in both meeting everyday expenses and enabling domestic or international growth. We provide businesses with finance solutions which can be tailored through our dedicated experts.

- We can work alongside you to support you in achieving your business ambitions and long-term success.
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- We can provide finance to support you with improving cash-flow, refinancing existing debt, buying assets, funding acquisitions and buyouts and a range of other requirements.

Providing support to businesses of any size or complexity, Letters of Credit can help cover your trading risks by allowing you to protect against defaults on payments from overseas and guarantee your own payments abroad.

Is it right for you?

You are entering into new relationships with buyers or suppliers in emerging markets and are looking to trade safely.

Offers exporters non-recourse finance as soon as compliant documentation is presented with a ‘term’ Letter of Credit.

Letters of Credit often act as ‘gateways’ to a whole range of other international products and services, such as foreign exchange products and risk mitigation, where income benefits can be extensive.

As an exporter, you are looking for security of payment.

As an importer, you wish to strengthen your credit worthiness

How it supports your business

Gives you the reassurance of a secure, globally recognised method of settling overseas trade.
Offers flexibility as we can match your Letter of Credit to your business needs and payment can be made for any amount and in any freely traded currency.
Allows you to strengthen your trading relationship by offering better credit terms to overseas buyers if you are exporting goods.
Enables you to negotiate improved credit terms if you are importing goods, thereby improving your cashflow
Your Letters of Credit will be subject to the International Chamber of Commerce’s rules for Documentary Credits providing you with reassurance that worldwide standards apply to you and your trading partner.

Export Letters of Credit

Export Letters of Credit are conditional payment undertakings issued by your buyer’s bank on their behalf. They give you certainty that you will receive payment for the goods you’re exporting providing you meet the terms of the Letter of Credit. If you ask us to confirm the Letter of Credit, you will have protection against payment default by the buyer’s bank.

In addition to being a secure and fast way to receive payment, Export Letters of Credit enable you to more effectively manage your cashflow by securing a known payment date, currency and amount.

Import Letters of Credit

Import Letters of Credit are conditional payment undertakings issued by us to your supplier on your behalf. They secure payment for your supplier providing they meet the terms of the Letter of Credit, for example presentation of documents such as a Bill of Exchange, Invoice, Bill of Lading or an Airway Bill. This gives you more control, which can be a particular advantage when buying from new suppliers.

Import Letters of Credit can also enhance your trading status by supporting your credit status. They can be valuable for negotiating terms such as a longer credit period or lower prices.