What Is a Bank Guarantee? How They Work, Types, and Examples

What is a Banker's Guarantee?

A banker’s guarantee is a form of commitment from a bank or other lending institution that if a borrower defaults on a loan, the bank will reimburse the loss. Bank guarantee essentially provides a safety net for the beneficiary, ensuring that the contract or agreement's responsibilities are met even if the other party fails to comply.  This assurance encourages trust and confidence among parties involved in a business transaction.

In a bank guarantee, three parties are involved: the applicant (the party who seeks the bank guarantee), the beneficiary (the party who receives the guarantee), and the issuing bank. The applicant approaches the issuing bank to request a bank guarantee, which assures the beneficiary that contractual obligations will be met. 

If the applicant fails to pay or carry out their financial obligations, the beneficiary may seek the guaranteed amount from the issuing bank. This process transfers the risk to the bank, which thoroughly evaluates the applicant's creditworthiness before issuing a guarantee. As a result, bank guarantees play an important role in facilitating smooth and secure payments and business transactions, thereby increasing trust between parties.

Why do Businesses Need a Banker's Guarantee?

Businesses frequently require a bank guarantee to reassure partners that they can meet the terms of a contract. It offers an additional layer of security, allowing for smoother transactions, particularly in large deals or international trade. Without a bank guarantee, some businesses may hesitate to enter into contracts or agreements, particularly with unknown third parties.

A bank guarantee can also help businesses gain access to goods, services, or credit that they would not otherwise be able to obtain. For example, a small company may use a bank guarantee to reassure a supplier and secure a large order. It assures the supplier they will be paid, even if the small business experiences financial difficulties.

Different Types of Bank Guarantees

Just as there are many types of business transactions, there are also different types of bank guarantees. Two common ones are performance guarantees and financial guarantees.

Performance Guarantee/Performance Bond 

A performance guarantee, also known as a performance bond, is a banker’s guarantee that makes sure a project or contract is completed according to the agreed-upon terms. It ensures the beneficiary that the work will be completed on time and to the required standard. If the contractor fails to meet these specified conditions, the performance guarantee entitles the beneficiary to compensation, providing financial protection against potential losses or delays caused by non-compliance.

For example, a construction company may offer a performance guarantee to a client. This assures the client that the construction project will be finished according to the contract. Suppose the construction firm is unable to meet its obligations. In that case, the guarantee facilitates the client's recourse by allowing the bank to financially support hiring an alternative contractor to complete the remaining work. This ensures the project's completion without undue delay or financial strain on the client.

Financial Guarantee

A financial guarantee is a promise to cover a payment or an obligation if the debtor fails to fulfill it. It assures the creditor that they will receive the payment or service, even if the debtor encounters financial difficulties.

Financial guarantees tend to be used when a debtor's creditworthiness is uncertain or not yet established. They are essential to facilitate transactions that might otherwise be too risky. This can be done by moving the financial risk from the creditor to the guarantor. Typically, the guarantor is a financial institution that evaluates and agrees to take on the potential obligation under specific circumstances.

A business, for example, may submit a financial guarantee to a lender when applying for a loan. If the company defaults on its loan, the bank will cover the repayment. This guarantee acts as a safety net, protecting the lender's investment against default. It also decreases the lender's risk and may help the company acquire a loan that they would not have been able to obtain otherwise.

Bank Guarantee in Singapore

DBS and OCBC are financial institutions that offer customized services for bank guarantee in Singapore, catering to various needs.

DBS Bank Guarantee

DBS facilitates both performance and financial bank guarantees, with fees based on the tenor. Bank guarantee fee for performance guarantees are 1% per year for tenors of up to two years and 1.5% per year for more extended periods. Financial guarantees carry a 2% annual cost, with a minimum charge of $100.

For DBS, applying for a banker's guarantee is straightforward. Businesses can apply online at their convenience. The application process is quick, with the guarantee expected to be issued within three working days. As a bonus, DBS can waive the processing fee and give free local delivery of the document, further simplifying the procedure.

OCBC Bank Guarantee

OCBC, on the other hand, offers a distinct approach for companies without a trade credit facility, charging a bank guarantee fee of 2% per annum or a minimum of $500 for ad-hoc bank guarantees. This option is particularly beneficial for SMEs requiring occasional guarantees, providing them with a financial safety net without needing ongoing credit facilities.

OCBC offers a similarly straightforward application process.  Companies can either visit an OCBC Trade Service Centre or send their application via email. This flexibility allows firms to choose the method that best meets their needs. 

Banker’s Guarantee Format

A banker’s guarantee format is designed to fulfill clients' needs and compliance requirements.

This contract typically consists of several key components. It specifies the guaranteed amount, validity period, and the specific conditions under which the guarantee can be invoked. It also defines the obligations of the principal (the party requesting the guarantee) and the beneficiary's rights (the party to whom the guarantee is issued).

A bank guarantee’s format also includes information about the issuing bank's commitment to pay the beneficiary on demand and within the agreed-upon terms, assuring that financial or performance obligations will be met. The terms outlined are essential for making sure all parties understand their respective responsibilities and the scope of the guarantee.

Bank Guarantee Example:

Below is an example of a banker’s guarantee that formalizes an agreement between the Bank of Singapore (guarantor), ABC Company (beneficiary), and Mr. George (applicant). It outlines the terms under which the Bank of Singapore unconditionally and irrevocably guarantees Mr. George's obligations to ABC Company up to a specified amount, including the conditions, validity period, and legal framework that governs the guarantee.

Date: 01/01/2024

BANK GUARANTEE NO.: 44445555

FOR: S$500,000 (Five Hundred Thousand Singapore Dollars Only)

RE: GUARANTEE IN FAVOUR OF ABC COMPANY

Dear Sirs,

In consideration of ABC Company (hereinafter referred to as the "Beneficiary") entering into an agreement with Mr. George (hereinafter referred to as the "Applicant"), we, the Bank of Singapore, unconditionally and irrevocably guarantee to pay to the Beneficiary any sum or sums not exceeding in total an amount of S$ 500,000 (Five Hundred Thousand Singapore Dollars Only) upon receipt by us of the Beneficiary's first written demand stating that the Applicant has failed to fulfill his contractual obligations.

This guarantee shall be valid and binding upon the Bank of Singapore from [01/01/2024] to [30/01/2024] (both dates inclusive) and shall cover all claims made in writing to us within this period.

Our liability under this guarantee is strictly limited to the amount specified herein and shall not be affected by any change in the constitution or the operations of the Beneficiary or the Applicant.

This guarantee is subject to the laws of the Republic of Singapore and may not be assigned or transferred without our prior written consent.

Claims under this guarantee must be received by us at the address above on or before the expiry date. Any claims received after the expiry date shall not be entertained.

This guarantee is issued at the request of the Applicant and upon the condition that the Applicant indemnifies us against all liabilities, claims, losses, and expenses that may be incurred by us in relation to this guarantee.

Yours faithfully,

For BANK OF SINGAPORE

[Authorized Signatory's Name]
[Authorized Signatory's Position]
Bank of Singapore

Banker's Guarantee vs. Letter of Credit

A bank guarantee and letter of credit are financial tools used in business transactions, but they serve different purposes. A banker’s guarantee is a promise from a bank that a debtor's liabilities will be met if they fail to fulfill them. On the other hand, a letter of credit guarantees from a bank that a buyer's payment to a seller will be received on time and for the correct amount.

While both offer security in business transactions, a bank guarantee is more adaptable and can be used as advance payment in various situations. A letter of credit is widely utilized in international transactions to ensure payment is received when the buyer and seller do not know each other or are in different countries.

Performance Bond vs. Bank Guarantee

Performance bonds and bank guarantees are types of financial securities that back up contractual obligations. A performance bond, which is commonly used in construction, ensures that a project is completed according to the terms of the contract. A bank guarantee, on the other hand, is broader, covering a wide range of obligations across industries and ensuring that a party meets its contractual obligations, whether financial or otherwise. While performance bonds are focused on project completion, bank guarantees provide broader financial assurance and can be tailored to a variety of contractual scenarios.

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