A bank guarantee is a pledge on the part of a bank to make someone’s debt good in the event that he or she cannot pay it. These types of guarantees are essentially like agreements to stand as a cosigner on a transaction; in the event that the original party cannot follow through, the bank can be called upon to provide the payment. Many banks offer bank guarantees as a service to their customers for the purpose of facilitating large business operations and deals, and this particular banking tool is primarily used by big customers such as corporations and governments.
From the perspective of a seller in such transactions, a bank guarantee is a letter of surety. It means that if the buyer takes possession and fails to pay, the seller can still recover the payment, from the buyer’s bank. Bank guarantees may be used in situations where large amounts of financing are needed and it is not possible to obtain a loan from one location, as for example when the World Bank provides such a guarantee for a development project, and for deals on a smaller scale.
In a direct guarantee, a bank directly guarantees someone, usually for a set amount and within a set period of time. The guarantee may also be generated for a specific transaction. Indirect guarantees are issued by one bank on behalf of another’s customer, as for example when a foreign bank stands surety for someone by arrangement through that person’s domestic and primary bank.
These guarantees are not handed out freely. Before a bank guarantee will be issued, the bank conducts a thorough investigation. Banks have no interest in taking on obligations for debts which they will probably have to pay, and thus people who are serious credit risks cannot obtain a bank guarantee. The bank also pays for this service. Fees vary, depending on the bank, and may be based on a percentage of the overall amount being guaranteed.
The bank guarantee is one among many instruments which organizations can use to obtain and secure financing in order to expand, complete projects, and perform other tasks. It is not necessarily the best option, however. Before pursuing a bank guarantee, people should sit down with financial advisors to discuss the array of options available to them and to determine which would be most appropriate.