A bank guarantee is a pledge by a bank to assume liability for a sale or contract between a buyer and seller. The buyer applies to the bank, which assesses the buyer’s ability to fulfill the contract and, if approved, charges a fee for the guarantee. If the buyer fails to pay for the purchase or complete the terms of the contract, the bank will make a financial payment to the seller. Bank guarantees help sellers manage risk and give small or unknown companies the creditworthiness they need to conduct business. Ask a financial advisor how a bank guarantee can help you.
Bank Guarantee Basics
A bank guarantee is a promise by a lending institution to make good on the financial terms of a sale, loan, lease or other contract in case the buyer fails to fulfill its obligation. For instance, if a seller provides a buyer with products and the buyer later does not pay for them, a bank that has issued a guarantee will step in and pay the price for the products.
The buyer applies for the guarantee and is called the applicant. The seller is the beneficiary that will receive payment. The bank is the guarantor that will make the payment if the buyer fails to.
The terms of a bank guarantee include the dollar amount of the guarantee, which is the sum that will be paid to the beneficiary in the event of the applicant’s default. The terms will also specify a time limit for the guarantee and the circumstances that constitute a default.
Before issuing a guarantee, the bank will assess the ability of the applicant to fulfill terms of the contract. If the assessment is positive, the bank will collect a fee, usually less than 1% of the value of the contract, in exchange for making the guarantee.
Types of Bank Guarantees
A bank guarantee may be financial or based on performance. A financial bank guarantee states that the applicant has to pay the beneficiary a specified sum for a purchase, loan, lease or other transaction. If the sum isn’t paid according to the terms of the contract, the beneficiary can invoke the guarantee and ask the bank for payment of the amount at issue.
With a performance-based guarantee, the terms may call for the applicant to deliver a product, complete a project or perform another task by a certain date. If the applicant doesn’t fulfill its obligations, the beneficiary can turn to the bank for financial compensation.
Other types of bank guarantee also exist. A loan guarantee requires the guarantor to repay a loan in case a borrower defaults. A shipping guarantee protects shippers from loss in case customers fail to pay. An advance payment guarantee protects buyers from loss of advance payments to sellers.
Bank Guarantee Uses
Bank guarantees reduce risk for sellers and allow smaller, unknown or less creditworthy buyers to conduct business. They are often used in international trade, when a seller is providing goods to a buyer based in another country and requires additional certainty that the price will be paid. Guarantees may also be used when signing leases or when obtaining loans.
Bank guarantees help companies do business by reducing risk and uncertainty. For example, a large company considering advancing a small business $50,000 worth of products to be paid for later may be unsure the buyer will pay as required. A financial bank guarantee can reassure the seller that, should the buyer fail to pay, the bank will pay the $50,000 sale price. This allows the deal to go through.
Bottom Line
A bank guarantee ensures that a seller will be paid by the bank issuing the guarantee if the buyer fails to pay. Bank guarantees can also cover performance, such as supplying products or completing projects by predetermined dates. In either case, the bank assesses the buyer’s ability to pay or perform, then charges a small fee in exchange for making the guarantee. If the buyer falls short, the seller can turn to the bank for compensation under the terms of the guarantee.
Investment Tips for Homebuyers
- A financial advisor can help you decide whether and how to manage risk in your investments. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Property taxes are collected by local governments and usually based on the value of a property. The money collected is generally used to support community safety, schools, infrastructure and other public projects. SmartAsset’s property tax calculator can help you estimate the average cost of property taxes in your state and county.
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