WHAT IS A BANK GUARANTEE?
A Bank Guarantee is where one Bank (the Issuing Bank) issues an indemnity to another Bank (the Beneficiary Bank) or directly to a Beneficiary, on behalf of its account holder. The Issuing Bank will expect its account holder to pledge ‘assets’ to the bank for its issue.
There are effectively two main types of Bank Guarantees,:
(1) A Direct Guarantee where the account holder instructs his bank to issue a Guarantee directly in favour of the Beneficiary, and
(2) An Indirect Guarantee where a second bank is requested to issue a Guarantee in return for a counter-Guarantee. In this case the Issuing Bank will indemnify losses made by this second bank in the event of claim against the Guarantee.
A Bank Guarantee is considered a “Demand Guarantee” and as such is governed by the International Chamber of Commerce (ICC) Uniform Rules for Demand Guarantees (URDG).
Some Guarantees are written to guarantee rental payments, some are written to guarantee payments upon the meeting of certain conditions. Some are even issued to guarantee loans and credit lines. All of them are written for a specific purpose to a specific party.
Each Bank Guarantee will be worded for the purposes it is intended. Some may be ‘callable upon demand’ or some may only be ‘callable’ when the Beneficiary provides notice of satisfaction of a pre-determined condition.
Currently, under the new Uniform Rules for Demand Guarantees (URDG 758) an underlying contract should be provided that states clearly the purpose of the Bank Guarantee and forms part of the Guarantee, for example a Rent Agreement or Payment Obligation.
CHARACTERISTICS OF BANK GUARANTEES
Some important characteristics of Bank Guarantees should be noted:
· Bank Guarantees are written specifically for a purpose; where an account holder will instruct his bank to issue a guarantee to another bank on behalf of their account holder.
· The bank will hold adequate assets of the account holder as security for the Bank Guarantee.
· They cannot be bought or sold.
· They do not carry CUSIP or ISIN numbers and are not tradable securities.
· They are issued for a specific time period. Upon Expiry, Bank Guarantees are terminated, they are not traded.
· A Bank Guarantee has no end value and does not accumulate any investment element or maturity value.
· They should not be considered as ‘investment notes’.
· They should not be ‘touted’ on the open market as the issue of a Bank Guarantee is between closed parties (the Issuer and Beneficiary only).
· Banks do not issue them to raise money and should not be confused with Medium Term Notes (MTNs).
· The strength of a Bank Guarantee is limited to the financial standing (and rating) of the Issuing Bank
ISSUING A BANK GUARANTEE
Any person or corporate entity with an account held at a mainstream bank can apply to issue a Bank Guarantee. Provided they hold to their account adequate assets, there should be no reason why a Bank will reject an application to issue a Bank Guarantee for bona-fide business purposes.
The account holder will simply request his Bank to issue a Guarantee and supply them with the reasons behind its issue. The bank would have a simple application form for this service. The account holder will submit the bank the application containing details of the underlying commitment being entered into whilst supplying the bank with information such as; (a) how long the Guarantee should be for, (b) any conditions on the payment, (c) the amount and currency, and of course (d) details of the Beneficiary and their bank details etc.
The Bank in-turn will request that the account holder enters into some form of pledge agreement with them. This means that before the bank agree to issue a Guarantee, the Bank would require a pledge or lien over assets of the account holder to secure the Guarantee. The assets acceptable for a bank to issue a Guarantee are generally liquid assets such as cash at bank, stocks and shares and bonds. In other words, assets that can be instantly liquidated. It is increasingly less common for banks to accept less liquid assets such as real estate property, although the decision to accept the asset is ultimately that of the bank.
In essence and for example, if an account holder wanted to issue a third party with a Bank Guarantee for 41.53 € million, it would be necessary to pledge cash, stocks or bonds to the his bank for a minimum of this amount. It is highly unlikely that a bank would agree to issue a Guarantee on behalf of their account holder without holding assets of equal or higher value. It is ‘for value received…..’.
Once the bank has charged, liened or blocked the assets on the account holders bank account at the bank, the same bank will issue a Guarantee in accordance with their account holders specifications.
The Issuing Bank will remit the Bank Guarantee to the Beneficiary Bank initially by SWIFT. See SWIFT
Normally, the Bank may pre-advise the Beneficiary Bank by sending a SWIFT MT799 which is only a notice outlining the Issuing Banks instructions to remit a Guarantee, or to verify information in advance of the issue.
The Issuing Bank will then send the Bank Guarantee also by SWIFT MT760. See MT799 and MT760.
Most banks will also send an original paper copy (which takes the appearance of a letter) by post to the Beneficiary Bank. It is courteous for the Beneficiary Bank to remit a message or letter back to the Issuing Bank confirming its safe receipt and acknowledgment.
RECEIVING A BANK GUARANTEE
If you are lucky enough to have a Bank Guarantee issued to you, you will certainly know what it is for. Most commonly, landlords may receive Bank Guarantees for rent deposits from their tenants for example. If you have entered into a separate contract for an investor to issue you a Bank Guarantee to secure a credit line, then you would have certainly executed contracts with them by this stage.
It is highly unlikely that a Bank Guarantee will pop onto your bank account by surprise! If you do receive a Bank Guarantee and have no idea why, you should contact your bank immediately.
In receiving a Bank Guarantee, your bank will generally notify you and send you a copy of it (normally a SWIFT terminal printout) for your information. They will also inform you that it is verified and valid and will await your further instructions.
If you plan to receive a Bank Guarantee, it is important that you bank with a multi-national bank that understands them and can offer you a ‘private’ banking service. Generally we would advise working with Swiss Banks who operate the procedure well.
If you are intending to receive a Bank Guarantee from an ‘investor’ in order to secure a line or credit or loan, it is important to negotiate this facility with your bank before the Bank Guarantee arrives. This will save time and expenses.
The Bank Guarantee will normally be posted to a separate account in your name that the bank will open upon its arrival. It will be held on this account until it is either called for payment or it expires.
FINANCIAL BANK GUARANTEE AND PERFORMANCE BANK GUARANTEE
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.
BANK GUARANTEES (BG) AND STANDBY LETTERS OF CREDIT (SBLC)
A Bank Guarantee (MT-760) is a financial instrument with a defined value that is issued by a bank with full banking responsibility. A Bank Guarantee is a written obligation of the issuing bank to pay a sum on to a beneficiary on behalf of their customer in the event that the customer himself does not pay the beneficiary.
BANK GUARANTEE VS SBLC – WHICH IS BETTER?
Bank Guarantees and SBLC (Standby Letters of Credit) are both financial instruments but each has a very different financial purpose. Most banks can issue either a Bank Guarantee or an SBLC so we are often asked by clients which one is better?
If your primary purpose is to have your Bank Guarantee or SBLC monetized, discounted or funded so you receive the most amount of cash from the instrument as possible. Then a BANK GUARANTEE will be BETTER!
The reason is funders who monetize Bank Guarantees and SBLC (Standby Letter of Credit) prefer Bank Guarantees and generally pay MORE for Bank Guarantees than they do for SBLC. LTV (Loan to Value) ratios on Bank Guarantees tend to be higher than SBLC so if your sole goal is to maximize the monetized return from your financial instrument, request a Bank Guarantee Not an SBLC.
A Bank Guarantee is where one Bank (the Issuing Bank) issues an indemnity to another Bank (the Beneficiary Bank) or directly to a Beneficiary, on behalf of its account holder. The Issuing Bank will expect its account holder to pledge ‘assets’ to the bank for its issue.
There are effectively two main types of Bank Guarantees,:
(1) A Direct Guarantee where the account holder instructs his bank to issue a Guarantee directly in favour of the Beneficiary, and
(2) An Indirect Guarantee where a second bank is requested to issue a Guarantee in return for a counter-Guarantee. In this case the Issuing Bank will indemnify losses made by this second bank in the event of claim against the Guarantee.
A Bank Guarantee is considered a “Demand Guarantee” and as such is governed by the International Chamber of Commerce (ICC) Uniform Rules for Demand Guarantees (URDG).
Some Guarantees are written to guarantee rental payments, some are written to guarantee payments upon the meeting of certain conditions. Some are even issued to guarantee loans and credit lines. All of them are written for a specific purpose to a specific party.
Each Bank Guarantee will be worded for the purposes it is intended. Some may be ‘callable upon demand’ or some may only be ‘callable’ when the Beneficiary provides notice of satisfaction of a pre-determined condition.
Currently, under the new Uniform Rules for Demand Guarantees (URDG 758) an underlying contract should be provided that states clearly the purpose of the Bank Guarantee and forms part of the Guarantee, for example a Rent Agreement or Payment Obligation.
CHARACTERISTICS OF BANK GUARANTEES
Some important characteristics of Bank Guarantees should be noted:
· Bank Guarantees are written specifically for a purpose; where an account holder will instruct his bank to issue a guarantee to another bank on behalf of their account holder.
· The bank will hold adequate assets of the account holder as security for the Bank Guarantee.
· They cannot be bought or sold.
· They do not carry CUSIP or ISIN numbers and are not tradable securities.
· They are issued for a specific time period. Upon Expiry, Bank Guarantees are terminated, they are not traded.
· A Bank Guarantee has no end value and does not accumulate any investment element or maturity value.
· They should not be considered as ‘investment notes’.
· They should not be ‘touted’ on the open market as the issue of a Bank Guarantee is between closed parties (the Issuer and Beneficiary only).
· Banks do not issue them to raise money and should not be confused with Medium Term Notes (MTNs).
· The strength of a Bank Guarantee is limited to the financial standing (and rating) of the Issuing Bank
ISSUING A BANK GUARANTEE
Any person or corporate entity with an account held at a mainstream bank can apply to issue a Bank Guarantee. Provided they hold to their account adequate assets, there should be no reason why a Bank will reject an application to issue a Bank Guarantee for bona-fide business purposes.
The account holder will simply request his Bank to issue a Guarantee and supply them with the reasons behind its issue. The bank would have a simple application form for this service. The account holder will submit the bank the application containing details of the underlying commitment being entered into whilst supplying the bank with information such as; (a) how long the Guarantee should be for, (b) any conditions on the payment, (c) the amount and currency, and of course (d) details of the Beneficiary and their bank details etc.
The Bank in-turn will request that the account holder enters into some form of pledge agreement with them. This means that before the bank agree to issue a Guarantee, the Bank would require a pledge or lien over assets of the account holder to secure the Guarantee. The assets acceptable for a bank to issue a Guarantee are generally liquid assets such as cash at bank, stocks and shares and bonds. In other words, assets that can be instantly liquidated. It is increasingly less common for banks to accept less liquid assets such as real estate property, although the decision to accept the asset is ultimately that of the bank.
In essence and for example, if an account holder wanted to issue a third party with a Bank Guarantee for 41.53 € million, it would be necessary to pledge cash, stocks or bonds to the his bank for a minimum of this amount. It is highly unlikely that a bank would agree to issue a Guarantee on behalf of their account holder without holding assets of equal or higher value. It is ‘for value received…..’.
Once the bank has charged, liened or blocked the assets on the account holders bank account at the bank, the same bank will issue a Guarantee in accordance with their account holders specifications.
The Issuing Bank will remit the Bank Guarantee to the Beneficiary Bank initially by SWIFT. See SWIFT
Normally, the Bank may pre-advise the Beneficiary Bank by sending a SWIFT MT799 which is only a notice outlining the Issuing Banks instructions to remit a Guarantee, or to verify information in advance of the issue.
The Issuing Bank will then send the Bank Guarantee also by SWIFT MT760. See MT799 and MT760.
Most banks will also send an original paper copy (which takes the appearance of a letter) by post to the Beneficiary Bank. It is courteous for the Beneficiary Bank to remit a message or letter back to the Issuing Bank confirming its safe receipt and acknowledgment.
RECEIVING A BANK GUARANTEE
If you are lucky enough to have a Bank Guarantee issued to you, you will certainly know what it is for. Most commonly, landlords may receive Bank Guarantees for rent deposits from their tenants for example. If you have entered into a separate contract for an investor to issue you a Bank Guarantee to secure a credit line, then you would have certainly executed contracts with them by this stage.
It is highly unlikely that a Bank Guarantee will pop onto your bank account by surprise! If you do receive a Bank Guarantee and have no idea why, you should contact your bank immediately.
In receiving a Bank Guarantee, your bank will generally notify you and send you a copy of it (normally a SWIFT terminal printout) for your information. They will also inform you that it is verified and valid and will await your further instructions.
If you plan to receive a Bank Guarantee, it is important that you bank with a multi-national bank that understands them and can offer you a ‘private’ banking service. Generally we would advise working with Swiss Banks who operate the procedure well.
If you are intending to receive a Bank Guarantee from an ‘investor’ in order to secure a line or credit or loan, it is important to negotiate this facility with your bank before the Bank Guarantee arrives. This will save time and expenses.
The Bank Guarantee will normally be posted to a separate account in your name that the bank will open upon its arrival. It will be held on this account until it is either called for payment or it expires.
FINANCIAL BANK GUARANTEE AND PERFORMANCE BANK GUARANTEE
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.
BANK GUARANTEES (BG) AND STANDBY LETTERS OF CREDIT (SBLC)
A Bank Guarantee (MT-760) is a financial instrument with a defined value that is issued by a bank with full banking responsibility. A Bank Guarantee is a written obligation of the issuing bank to pay a sum on to a beneficiary on behalf of their customer in the event that the customer himself does not pay the beneficiary.
BANK GUARANTEE VS SBLC – WHICH IS BETTER?
Bank Guarantees and SBLC (Standby Letters of Credit) are both financial instruments but each has a very different financial purpose. Most banks can issue either a Bank Guarantee or an SBLC so we are often asked by clients which one is better?
If your primary purpose is to have your Bank Guarantee or SBLC monetized, discounted or funded so you receive the most amount of cash from the instrument as possible. Then a BANK GUARANTEE will be BETTER!
The reason is funders who monetize Bank Guarantees and SBLC (Standby Letter of Credit) prefer Bank Guarantees and generally pay MORE for Bank Guarantees than they do for SBLC. LTV (Loan to Value) ratios on Bank Guarantees tend to be higher than SBLC so if your sole goal is to maximize the monetized return from your financial instrument, request a Bank Guarantee Not an SBLC.
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