Bank guarantee in India is an agreement between three parties (debtor, creditor, and bank) from a bank in which the Bank would fulfill the obligations of the debtor if the debtor fails to do so. Bank guarantee is an important banking arrangement and plays a vital role in promoting international and domestic trade.
In running a business, sometimes situations arise when 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 a bank guarantee.
Bank guarantee agreement in India acts as an undertaking. It assures the beneficiary that the bank would pay the specified amount, in the case of its applicant’s default in delivering the “financial” or “performance” obligation as mentioned in the guarantee.
In effect, the bank guarantee acts as a promise that in case the liabilities of the debtor/applicant are not met, the contractual liability will be met by the bank. It is to be noted that the obligation to pay is not of the applicant, but of the bank since the bank acts as the guarantor.
Different Features Of Bank Guarantee In India
- 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.
- Bank Guarantees cannot be transferred to third parties unknown to the banks.
- They cannot be bought or sold.
- Additionally, 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’.
- 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 In India
Any individual or a 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 bonafide 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.
Generally, the bank agrees to issue a bank guarantee with conditions. The bank in turn will request the account holder enters into some form of pledge agreement with them. Generally, the bank accepts liquid assets to issue a guarantee.
The list includes cash at the 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.
Different Types Of Bank Guarantee In India
There are various different types of bank guarantees in India you will find for different specific purposes. Those are as follows:
1. Performance Guarantee
Performance guarantee is used as collateral in transactions involving a buyer and a seller. A performance guarantee is typically invoked if the buyer incurs the cost and the seller does not deliver goods or services as promised in the contract.
2. Bid Bond Guarantee
Bid bond guarantees are typically used in tenders. It ensures that the winning bidder undertakes the contract as per the terms of their winning bid. In case a winning bidder does not perform the tender requirements as stipulated, then the tender issuer can invoke the bank guarantee and fully or partially forfeiture the amount.
3. Financial Guarantee
The financial guarantee is an undertaking from a bank. Here a company takes responsibility for another company’s financial obligation if that company does not meet its responsibility.
4. Advance Payment Guarantee
An advance payment guarantee is used to protect the advance payment made by a buyer to a seller. It happens in case the seller fails to deliver goods or services as per the terms and conditions of a trade transaction. Therefore, the buyer can invoke the advance payment guarantee to recover a full or partial advance payment made to the seller.
5. Foreign Bank Guarantee
A foreign bank guarantee is used in international trade. Basically, foreign bank guarantees are those guarantees issued for the benefit of a foreign beneficiary.
5. Deferred Payment Guarantee
Deferred payment guarantees are used when one party in a transaction undertakes to make payment of a fixed amount at corresponding times in the future. In case, the debtor is unable to pay, then the deferred payment guarantee can be invoked to claim the money.