Benefits of Bank Guarantee in Local & Export Business
What are the benefits of a bank guarantee, and what the main procedures to get it? I am a businessman, and what I hate most is any deal devoid of payment assurance. Every seller is keen at dealing with able buyers who can make payment as and when due.
Ultimately, sellers do not want to be at the mercy of fake buyers, so they demand payment assurance in advance. In this article, I will focus on the features and gains of bank guarantee as a means of payment.
What is a Bank Guarantee?
A bank guarantee is an assurance from a bank promising to meet their debtor’s financial obligations if he defaults payment at the end of a business transaction. Unlike a documentary letter of credit that protects sellers ‘interest, BG protects both parties in any given business transaction. In other words, Bank Guarantee protects both parties against breach of contract by either of the two parties.
Also, a bank guarantee helps in securing both parties’ financial interest. In the case of default by a buyer, a bank guarantee helps in ensuring that sellers receive payment after delivery.
Process of Obtaining BG
How do you get your bank involved in a business deal, or what are the steps to obtaining BG? There is no uniform standard for getting BG because banks differ in how they mitigate risks.
However, let me provide you with a general guide that most banks follows.
The first step is for both buyer and seller to agree to the use of bank guarantee for their deal. Note that not all transactions require BG because some traders prefer Letters of Credit to it.
The second step is for the buyer to contact his bank. Having agreed with the seller on the use of BG, it’s time for the buyer to apply for it with a financial institution. Without any delay, it is time to make his request formal and provide his bank with details of his proposed deal.
The third stage is the bank’s assessment of the applicant. For the bank to agree to issue a guarantee, they will probe to know if there is payment assurance. In that case, they will demand necessary security in the form of collateral from the applicant.
The fourth stage is for the applicant to provide collateral if he does not have enough money in his account to fund the deal. Moreover, no bank wants to get trapped in any business. At this stage, the bank may reject the applicant’s request if he fails to provide all the needed security.
The fifth and final stage is the issuing and receiving of BG. Barring any obstacles, the bank will issue and deliver the bank guarantee to the applicant or the seller. Depends on the individual bank, the whole process will take some days before completion.
Why the Need for Bank Guarantee
As a buyer, there are times when your current book balance is not enough to close a deal. Also, you need your banks backing if you are contending with big companies on project bidding. A guarantee from your bank is a way of giving the necessary assurance before a company could agree to approve your bid.
Also, it is essential most especially when the company wants to protect itself against project abandonment due to lack of fund.
Benefits of Bank Guarantee
The benefits of bank guarantee include mitigation of payment default risk, waiving of initial financial commitment, and enhanced business opportunities. Other benefits include increased brand credibility, less documentation, and less cost of capital.
For clarity sake, let me explain further on some key benefits of BG as a payment instrument.
Mitigation of Payment Default Risk. As I mentioned earlier, a bank guarantee provides a seller with sufficient assurance of payment at the end of a deal. With a bank guarantee, a seller can reduce likely financial losses that may arise in case a buyer defaults.
No Initial Financial Commitment. When you make use of BG, it saves you from making any advanced payment to the seller. It prevents you from being at the mercy of fake sellers in a foreign land. Also, it is a payment instrument with which you can defer payment to your advantage.
Enhanced Business Opportunities. Your ability to prove that your bank is behind you will open more business opportunities to your company. It will earn you suppliers’ trust within and outside your country.
Increased Credibility for Your Brand: A guarantee from your bank is evidence of financial strength, and that will surely earn your company some credibility. Exporters don’t waste their time with insolvent companies but are ready to win credible buyers at all cost.
It is Economical. BG cost less and prevents you from losing much of your profits to your bank. Its cost-effectiveness makes it one of the most preferred payment instruments by importers.
It Requires Less Documentation: Bank guarantee does not require too much paper works. The two primary things banks want are your transaction details and financial strength. Note that the bank will not guarantee payment for any deal if you are not creditworthy.
Disadvantages of BG
There are few disadvantages common with bank guarantee. All banks put up stringent measures to protect themselves against losses. This measure may end up delaying the business transaction or even total loss of the business opportunity.
Also, applying for a guarantee from your bank when you are not creditworthy is a waste of time. That means bank guarantee is not within every business’ reach but for few financially stable companies. The issuing bank may also demand collateral, thereby making it inaccessible to some small businesses.
Furthermore, BG is not for a business transaction with a low margin profit. Although it cost little to obtain BG, you may end up losing a chunk of your profit to the issuing bank.
Types Of Bank Guarantee
There are different types of BG which include performance guarantee, payment guarantee, tender guarantee, and advanced payment guarantee. Other forms of BG include order and counter-guarantee, customs guarantee and project execution guarantee.
Performance Guarantee: Also referred to as a performance bond, it is collateral against default on the part of a supplier. It is provided by a supplier to protect a buyer against any loss he may suffer in case the seller fails to deliver.
Payment Guarantee: This protects a seller from being at the mercy of a financially starving buyer. It is a payment assurance from my buyer’s bank to a seller against the delivery of goods. Payment guarantee assures a seller that payment is available at an agreed date or time.
Tender Guarantee: Tender (bid) guarantee is a bank guarantee by which a guarantor undertakes to pay to a beneficiary a certain amount of money if a tender participant revokes its bid during the bidding process. Also, it applies to when bidder refuses to conclude a contract under conditions of the accepted tender.
Advance Payment Guarantee: This is a guarantee to ensure a buyer recover all advanced payment made to a seller who fails to deliver goods as agreed. To secure advanced cash paid via Red-Clause Letter of Credit, buyers usually demand Advance Payment Guarantee.
Order and Counter Guarantee: The counter-guarantee is a technical word to indicate the guarantee given by a bank to another bank issuing a guarantee.
Customs Guarantee: A customs guarantee is an agreement to cover a customs debt that has or will arise from some customs procedures. Some people refer to this as actual or potential debt.
Contract execution guarantee. This guarantee is a security of timely delivery of goods or performance of services according to a contract. It protects beneficiary against losses resulting from delay in delivery of cargoes and services.
A Typical Bank Guarantee Scenario
Let’s consider a real-life scenario. You need some petroleum products from Nigeria, and in the course of searching for reliable suppliers. You came across Tank Farm and Petroleum Products Marketing Ltd, and you send in your inquiries.
The first thing the company wants to know is whether you have the financial strength for your request or not. If we are not sure of payment after delivery, we have no choice but to demand your bank guarantees payment at the end of the proposed transaction.
Also, you may demand a performance guarantee from us to be sure we will not waste your time. Demanding performance bond from us will make us think twice before committing ourselves to any long term contract with you. That means transaction may not commence until both of us exchange guarantees.
Several reasons may prompt our demand for BG. If we are not sure of your financial strength or you usually delay payment even when you are financially solvent.
One of the ways banks make money is the provision of financial instruments such as bank guarantee to their customers. They act as payment escrow by taking custody of fund meant for a deal until all parties fulfil their contractual pledges. You can count on your bank whenever you need a third party financial vetting.
Contact us today to know how a Leased Bank Guarantee mt760 from barclays bank, hsbc bank, Chase Bank, Standard Chartered Bank or Bank of America can help you conclude worthy deals with your suppliers and contractors.