A bank guarantee is a type of guarantee from a lending institution. The bank guarantee means a lending institution ensures that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it. A bank guarantee enables the customer, or debtor, to acquire goods, buy equipment or draw down a loan.
BREAKING DOWN Bank Guarantee
A bank guarantee is when a lending institution promises to cover a loss if a borrower defaults on a loan. The guarantee lets a company buy what it otherwise could not, helping business growth and promoting entrepreneurial activity.
There are different kinds of bank guarantees, including direct and indirect guarantees. Banks typically use direct guarantees in foreign or domestic business, issued directly to the beneficiary. The term direct guarantee applies when the bank’s security does not rely on the existence, validity and enforceability of the main obligation. Individuals often choose guarantees for international and cross-border transactions, which can be more easily adapted to foreign legal systems and practices due to not having form requirements.
Indirect guarantees occur most often in the export business, especially when government agencies or public entities are the beneficiaries of the guarantee. Many countries do not accept foreign banks and guarantors because of legal issues or other form requirements. With an indirect guarantee one uses a second bank, typically a foreign bank with a head office in the beneficiary’s country of domicile. For example, Company A is a new restaurant that wants to buy $3 million in kitchen equipment. The equipment vendor requires Company A to provide a bank guarantee to cover payments before they ship the equipment to Company A. Company A requests a guarantee from the lending institution keeping its cash accounts. The bank essentially cosigns the purchase contract with the vendor.