A bank guarantee is a promise made by a bank or other financial institution that if a particular borrower defaults on a loan, it will cover the associated losses.
Through this bank guarantee, the bank will reassure the original creditor that if the borrower is unable to pay his or her debts, the bank will take care of them.
Business organizations frequently make use of bank guarantees. This is done so that the debtor, borrower, or customer will be able to acquire more finances, equipment, machinery, raw materials, etc. for business objectives with the aid of a bank guarantee.
Businesses benefit from bank guarantees because they provide adequate comfort to creditors that, if the firm is unable to repay the loan in full on time the bank will reimburse the loan amount. When a bank forms a bank guarantee, it commits to pay any sum at the borrower’s request. As a result, banks are taking a big risk by signing a bank guarantee.
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Typical Example of How A Bank Guarantee Works
Let’s say a farmer wants to buy R1 million worth of farming equipment. The seller then requires that before shipping the item, the farm owner acquire a bank guarantee that will ensure payment.
The farm owner will ask his bank for a bank guarantee and the bank will determine if the customer qualifies for a guarantee and has the financial wherewithal to repay. This will also determine the appropriate amount for the bank guarantee using the assessment information. Then, the bank will make sure to arrange a bank guarantee with a higher cost if the trade entails too much risk.
Types of Bank Guarantee
- Deferred payment guarantee: A bank guarantee or a payment guarantee that is provided to the exporter for a predetermined amount of time is referred to as a deferred payment guarantee. If the buyer’s bank guarantees that it will pay the buyer’s outstanding debts to the seller, the seller will extend credit to the buyer when they purchase capital goods or machinery. For failure to supply raw materials, machinery, or equipment, the bank will pay in installments under this kind of guarantee
- Financial guarantee: If a party does not fully execute a particular project or activity, money will be refunded according to a financial bank guarantee. Following the financial guarantee agreement, the bank will pay any late fees associated with project completion.
- Advance payment guarantee: The seller will get an advance payment under this type of guarantee. There will also be a guarantee that the buyer will get their money back if the seller doesn’t provide the service or item precisely or on time.
- Foreign bank guarantee: A bank offers a foreign bank guarantee on behalf of a borrower. The overseas beneficiary or creditor will make this offer on their behalf.
A local guarantee is given to a beneficiary in South Africa. A foreign guarantee is given to a recipient outside of South Africa. Foreign beneficiaries may receive guarantees directly from FNB or indirectly through a foreign bank.
- Performance guarantee: In the case of a performance guarantee, the bank will compensate you financially for any delays in the performance or operation. Even if the service is poorly provided, payment must be made.
- Bid bond guarantee: For this kind of guarantee, a supply bidding process will be used. This will be done on behalf of the owner of the business, whether it be an industrial enterprise, infrastructure project, or something else. The project’s contractor will ensure that the highest or best bidder has the power and ability to carry out a project according to his or her preferences. This bid bond will be provided to the project owner as a guarantee and will state that the project must be developed following the bid contract.
Advantages of Bank Guarantees
- Small businesses can get loans and engage in business. This, in return, promotes entrepreneurship and corporate expansion.
- A bank guarantee gives you peace of mind during a business transaction. It takes away barriers like late payments or missed deliveries that might impede easy commercial transactions.
- Guarantees also reduce risk. The buyer is safeguarded by a bank guarantee for the upfront payment. If the seller is unable to provide the products or services, it ensures that the customer will be reimbursed for the advance.
- When it comes to foreign transactions, determining the party’s credibility is a difficult procedure. However, parties can evaluate each other’s creditworthiness and financial stability in this case by using a bank guarantee.
Disadvantages of Bank Guarantees
- A bank’s participation in the transaction could slow it down and add needless bureaucracy and complication. The bank itself may demand assurance from the applicant in the form of collateral for transactions that are particularly of high value.
How do I get a bank guarantee in South Africa?
To obtain a guarantee, the account holder contacts the bank and completes an application that specifies the amount of the guarantee as well as the reasons for it. Typical applications specify the length of time the guarantee should be valid, any special payment conditions, and information about the beneficiary.
How much do banks charge for a bank guarantee?
Most bank guarantees come with a fee that is a small percentage of the total contract value, usually 0.5 to 1.5% of the guaranteed amount.
What are the documents required for bank guarantee?
- Bank guarantee application form
- A stamped letter of guarantee from the bank
- Paper for stamping (as per the State Stamp Act)
- In the case of a public/private limited company, a resolution passed by the board of directors is also required.