(Bank Guarantee Definition, Bank Guarantee Funding or Bank Letter of Guarantee )
A Bank Guarantee is a promise or Letter of Guarantee from a legitimate bank that the liabilities of a debtor or client/applicant will be met in the event that the debtor fails to fulfill the contractual obligations. Bank guarantees are used to assure a 3rd party of payment for a debt, contract agreement or obligation. The bank acts as the guarantor if and when the applicant defaults on the financial loan or performance obligation.
Essentially, it could be considered a kind of financial “insurance” for a buyer or seller in a contract if services are not performed as specified in the contract.
Other terms that may be used to refer to the Bank Guarantee process include Bank Guarantee Financing, Bank Guarantee Funding, Bank Letter of Guarantee or simply “BG“.
There are generally 2 kinds of Bank Guarantees: Performance Guarantees and Financial Guarantees.
A Performance Guarantee (performance bank guarantee) occurs when a bank backs the performance of one party in a contractual obligation, such as an international buyer’s ability to pay an international seller for goods shipped, or for a construction company in country “A” to complete a contracted building project for a government entity in country “B”.
A Financial Guarantee (financial bank guarantee) is used to back a financial commitment, such as a business loan or security deposit.
Bank Guarantee Process – How do Bank Guarantees work?
Bank Guarantees are used often to serve as a way to facilitate that business transactions and expansions can and will occur, whereby they might not other wise happen. It gives reassurance to the contracted entities on both sides of the deal or transaction. Essentially, because banks can offer guarantees, they enable transactions to occur whereby trust or other international barriers between parties may be too complicated to allow the transaction to occur, explained in the following International Bank Guarantee example.
International Bank Guarantee – Bank Guarantees are often used to back major projects that are occurring overseas, when the lender / provider of services would like reassurance that his company will be paid for performance. One generic example might be when ABC company wins a contract to build infrastructure, or a government building in a foreign country. The foreign country’s government may request an international Bank Guarantee to back the ABC construction company, in the event the company fails to perform on the building contract.
In other words, the foreign government puts its real “trust” in the backing bank.
International Bank Guarantees are also often used when goods are bought or sold between companies in different countries.
Let’s say Company B (the buyer) is buying goods from Company S (the seller). The Seller may want Company B to have it’s bank (or another international bank) issue a guarantee in the event Company B runs into cash flow issues or has problems paying for the goods provided by Company S. Company B’s Bank will do it’s “Due Diligence” on it’s client and the business transaction to be sure it’s client is credit-worthy and the transaction is sound. Once it has performed due diligence, it will issue a Bank Guarantee, often to the Seller’s Bank or directly to the Seller. If the Buyer runs into an issue in payment for goods or services, the Buyer’s Bank is now obligated to pay the Seller or Seller’s bank in order to fulfill the contractual obligations. This process is used in international transactions frequently in order to give the Buying Company the ability and backing to transact international business, and the Selling Company receives 3rd party reassurance that it will be compensated whether the buyer performs or fails.
Bank Guarantee Requirements – A Bank Letter of Guarantee will vary, depending on the bank issuing the guarantee, as well as the type of transaction. Essentially, the bank will do it’s due diligence on the project and the credit-worthiness of the performer of the contract. The Bank wants to be sure it’s client can perform the contractual obligations, so that the Bank does not lose money. The Bank Guarantee provides assurance to both parties, as it is a 3rd party financial institution that will make sure the applicant can perform so that it does not default.
What is the difference between a Bank Guarantee (BG) and Line Of Credit (LOC) or Standby Letter of Credit (SBLC)?
The major difference between a line of credit and a bank guarantee is that the bank guarantee comes into effect when the party backed by the bank fails to perform. With a line of credit (LOC) or SBLC (Standby Letter of Credit), the funds are guaranteed to come once certain contractual criteria are met, whereas, the BG kicks in when performance fails.
Both are guarantees from a bank, but one occurs after specific performance / contractual standards are met, while the other occurs when performance failure occurs.
Bank Guarantee Fees: Fees are normal in all private bank and investment bank or private investor transactions. In most cases, there will always be up front fees to cover the cost, work, effort, and sometimes 3rd party fact verification for the validity of a project or principals. Investors are not going to come “out-of-pocket” to approve of every applicant, and therefore they normally require some up front fees once engaged, in order to perform Due Diligence, to structure business projects properly for investment vehicles, and to hire outside sources to verify facts to validate the business, principals and the investment.
Up front fees are often also a deterrent to clients or applicants who are not serious or are not truly qualified to receive and handle the funds. Up-front, due diligence fees insure both parties that there is a mutual commitment to the process of getting funding for the project or contract.
Bank Guarantees and those involved in facilitating bank guarantees will also require fees to ensure the applicant’s commitment as well as their financial “soundness”. It is not realistic for an applicant to apply for millions of dollars in private or guaranteed funding without expecting to pay to have the investor or guarantor assure the client and project is worthy of being funded. Different banks also require different fees, often held in a 3rd party escrow account, in order for a client to qualify for the Bank Guarantee process. In order to find out the fees and specific process, one must apply for a Bank Guarantee or ask for an outline describing the process, timelines, and expectations of each party involved from the source who is qualified to issue or facilitate bank guarantees.
In order for larger Bank Guarantees to work, a Joint Venture is usually formed, which requires professionals to be paid to perform the work in creating the contractual vehicle, as well as paying any attorneys and other professionals involved, depending on the nature of the project, the size of the transaction, and the specifics that must be verified for the process to work successfully. Usually, there is a client (requesting the funds), a qualified facilitator (company that handles the transaction details for both parties), and a monetizer (the bank).
Although this is a very general overview of the Bank Guarantee process, no single article could explain the exact process for every Bank in detail, as some of the details vary depending on the bank, the facilitating party, and the process.
5th Avenue Capital provides private capital for project funding from $1M to $1BN, and can often provide up to 100% financing on qualified projects. To find out if your project qualifies for 100% private financing, please contact us here with the details of your project.
