Bank guarantee
A bank guarantee is a written undertaking given by a bank to cover various situations to support exporters or contractors. It is used as a protection against non-fulfilment of another party’s obligations. A Bank Guarantee is an irrevocable obligation, non-cancellable, by the bank to pay an agreed sum in case of the failure or default on the part of the party, on whose behalf it is issued, in fulfilling or performing a particular obligation. Bank guarantees do not normally involve any financing, but the bank may charge a ‘guarantee’ commission for the service on issuing their own guarantee and carrying the risk for the guaranteed period. In the case of Islamic banks, they issue guarantees under the Islamic concept of Kafalah.
Bank guarantees carry a risk for the issuing bank, which becomes liable to pay out against the guarantee in the event of default. Accordingly, the bank takes a liability risk and will first assess the client’s financial position before issuing any guarantee, in order to determine whether the client’s reputation and creditworthiness warrants the bank taking a risk on the performance of the client. The bank may take the necessary security to minimise any potential loss. These administrative expenses incurred in the process of issuing a guarantee justify the commission charged by the bank. Islamic banks are required to calculate the commission as a fixed amount on the guaranteed amount, without taking into account the period of the guarantee, as opposed to conventional banks which calculate guarantee commission based on the guaranteed amount and period of the guarantee.
The common types of guarantees are bid bond, performance bond, advance payment guarantee, shipping guarantee and standby letters of credit. A bid bond is issued by a bank on behalf of a client bidding to secure a contract or project, it guarantees that a bidder will not submit an unrealistic bid or, after winning the bid, fail to enter into an agreement. A performance bond is commonly used in transactions for supply and delivery of goods and services; it guarantees the performance of certain specified acts by the client. If the client fails to perform according to the contract, the bank performs according to the guaranteed commitments. An advance payment guarantee can be used by an importer to secure payment and decrease its risk; it consists of paying the exporter in advance of the manufacture or shipment of goods. A shipping guarantee is issued to assist importers to take delivery of goods from the port of arrival in the absence of the original shipping documents. It may include guaranteeing the payment of customs and other duties payable to the customs authorities by the importers to take delivery of their goods. Under the shipping guarantee, the bank undertakes that the importer will deliver the original shipment documents upon receipt in exchange for the guarantee letter and that the he will be liable for payment of all expenses arising thereon. And a standby letter of credit is a guarantee used as a payment of last resort in case the client fail to fulfil a contractual commitment with a third party. It is often used in international trade transactions that do no involve trade L/Cs. Standby letters of credit are usually created as a sign of good faith in business dealings and are proof of an importer’s credit quality and repayment ability. The exporter may ask for a standby letter of credit, against which immediate payment can be demanded if the importer fails to make payment by the date specified in the contract.
Bank guarantees carry a risk for the issuing bank, which becomes liable to pay out against the guarantee in the event of default. Accordingly, the bank takes a liability risk and will first assess the client’s financial position before issuing any guarantee, in order to determine whether the client’s reputation and creditworthiness warrants the bank taking a risk on the performance of the client. The bank may take the necessary security to minimise any potential loss. These administrative expenses incurred in the process of issuing a guarantee justify the commission charged by the bank. Islamic banks are required to calculate the commission as a fixed amount on the guaranteed amount, without taking into account the period of the guarantee, as opposed to conventional banks which calculate guarantee commission based on the guaranteed amount and period of the guarantee.
The common types of guarantees are bid bond, performance bond, advance payment guarantee, shipping guarantee and standby letters of credit. A bid bond is issued by a bank on behalf of a client bidding to secure a contract or project, it guarantees that a bidder will not submit an unrealistic bid or, after winning the bid, fail to enter into an agreement. A performance bond is commonly used in transactions for supply and delivery of goods and services; it guarantees the performance of certain specified acts by the client. If the client fails to perform according to the contract, the bank performs according to the guaranteed commitments. An advance payment guarantee can be used by an importer to secure payment and decrease its risk; it consists of paying the exporter in advance of the manufacture or shipment of goods. A shipping guarantee is issued to assist importers to take delivery of goods from the port of arrival in the absence of the original shipping documents. It may include guaranteeing the payment of customs and other duties payable to the customs authorities by the importers to take delivery of their goods. Under the shipping guarantee, the bank undertakes that the importer will deliver the original shipment documents upon receipt in exchange for the guarantee letter and that the he will be liable for payment of all expenses arising thereon. And a standby letter of credit is a guarantee used as a payment of last resort in case the client fail to fulfil a contractual commitment with a third party. It is often used in international trade transactions that do no involve trade L/Cs. Standby letters of credit are usually created as a sign of good faith in business dealings and are proof of an importer’s credit quality and repayment ability. The exporter may ask for a standby letter of credit, against which immediate payment can be demanded if the importer fails to make payment by the date specified in the contract.
