What is a Bank Guarantee?

A Bank Guarantee, direct or indirect, is often used as security to underwrite the borrowing party – usually the beneficiary of the Bank Guarantee, in case of default on an obligation. Transferring a Bank Guarantee is an easy process, where the client (Applicant or Provider), instructs their bank, (The Issuing Bank), to transfer a Bank Guarantee to another bank (The Receiving Bank), in favour of their client, (The Beneficiary).

On certain occasions a Standby Letter of Credit (SBLC), or a Documentary Letter of Credit (DLC), have been applied for instead of applying for a Bank Guarantee (BG). A lack of understanding over the payment process has produced this confusion. The explanation is simple. A Bank Guarantee is SECURITY for payment and a Standby Letter of Credit, or a Documentary Letter of Credit is a MEANS of payment.

A critical area for Bank Guarantees is what country has legal jurisdiction. In all cases the country that has enjoys jurisdiction is the country where the Issuing Bank is domiciled. For instance, if the issuing Bank is domiciled in Geneva, the law regarding Bank Guarantees is governed by the laws of Switzerland. It is therefore of vital importance that all Bank Guarantees are scrutinised on a case by case basis, as banking law differs from jurisdiction to jurisdiction.

It is important to understand why one guarantee differs from another guarantee. All guarantees are either direct guarantees or indirect guarantees. When a bank transfers a Direct Bank Guarantee, they transfer the Bank Guarantee direct to another Bank. When a bank transfers an Indirect Bank Guarantee, they have requested their banking correspondent to issue a Bank Guarantee on their behalf. It is fundamental for businesses to understand the difference between a Bank Guarantee, a Performance Guarantee and a Surety Bond. A Bank Guarantee is payable on Demand. A Performance Guaranty or Surety Bond, has underlying insurance factors and will therefore only reimburse once strict criteria have been met.

A Demand Bank Guarantee is a specialised form of Bank Guarantee, and through the use of the Collateral Transfer Facility, is used to raise loans or credit lines, referred to as Credit Facility Guarantees. The Demand Guarantee, makes use of a precise format, is payable on FIRST DEMAND and is governed by ICC Uniform Rules for Demand Guarantees (ICC 760).