Every business needs a backbone of funds for its effective operations and to maintain the competition in the market. Moreover, there are several debt instruments available for funding, while Bank Guarantees are the most used. Bank Guarantee (BG) is a type of financial instrument offered by a lending institution, where the lender will ensure that the liabilities of a debtor will be met. In the other words, the lender promises to cover a loss in case the borrower defaults on the loan. There are four parties involved in the transactions, the applicant/ borrower, the issuing bank, the beneficiary, and the beneficiary bank.
Features of Bank Guarantee
1. BG builds confidence between the lender and the borrower. It adds assurance of transaction between an exporter and importer. The major reason for opting for BG is that many times the exporter and importer are unaware of transacting with each other and there can be a risk in the transaction. Hence, to overcome this risk involved, Bank Guarantee clears the hurdles.
2. The BG is obtained for a specified period and as per the need and requirements of the borrower. The applicant can hold the BG only up to a specified period, they can further renew it after maturity.
3. The bank guarantee can or cannot hold assets against the instrument. The collateral depends upon the availability of the asset and the terms and conditions of the agreement between the lender and the borrower. It is also obtained without collateral.
Parties Involved
1. The applicant (importer): who requests BG from his banker as per the demand from the beneficiary
2. The issuing bank: as per the request from the applicant, the bank issues the BG on the beneficiary’s bank.
3. The beneficiary (exporter): is the party that demands BG.
4. The beneficiary’s bank: is the one who receives the BG on behalf of the beneficiary.
Example
“ABC Pvt Ltd” is an exporter company that deals with “XYZ Pvt Ltd”, and an importer. The exporter on shipping goods requests the importer to get the Bank Guarantee from his banker. The banker on demand from the customer applies for BG and reduces the risk involved in the transactions. After receiving the BG, the applicant submits a copy to his other party which eases the procedure in the business operations. Here, “XYZ Pvt Ltd” is the applicant, the bank is an issuing party, and “ABC Pvt Ltd” is a beneficiary.
Process for applying BG
1. The parties while transacting with each other, the exporter demands BG from the importer.
2. The importer requests his bank for the BG and submits the necessary documents.
3. After preparing BG, the bank communicates the same to the importer.
4. The importer then requests the bank to send the BG to the exporter’s bank.
5. The exporter’s bank on receiving BG communicates the same to the exporter.
6. The exporter then ships the goods to the importer after receiving the BG from the importer.
Learn more about bank guarantee process from the case study.
Difference — Bank Guarantee (BG) and Letter of Credit (LC)
In the case of BG, payment is made only in case of a default of the buyer. And, in the case of a letter of credit, payment is made on behalf of the customer after receiving the goods.
In the case of BG, payment is made at the non-fulfilment of the transaction between the parties. Whereas the LC payment is made only after the fulfilment of the condition specified.
In a conclusion:
Bank Guarantee is the finest instrument for businesses. It is issued to lenders by the borrower’s bank. The BG guarantees that the lender will get paid, even if the borrower defaults on the loan. We at Terkar Capital consult the aspiring entrepreneurs and promotes seamless funding solutions to them. We arrange and provide a wide range of products as per the client’s needs and expectations. The team guides the clients in each and every step of funding and preserves the confidentiality of the respective clients.
If not handled properly, the loan might do more harm than good.
You should avoid some of the mistakes and getting the risk free loan.
As a smart borrower, you have to remember the following things before the money you borrow.Check Your Credit ScoreYour credit score is essential.
Most of the lenders will recommend a loan based on your credit history.
If you have a low credit score, you should try to improve it so that you can be eligible for high loan amounts.
You can maintain a good credit score by cleanly paying your dues on time.Your Financial SituationYou should also consider the financial position that you are in.
