About Bank Guarantees
A Bank Guarantee is transferred by one bank to another bank to act as security in case the beneficiary of the Bank Guarantee fails to meet their obligation to the underlying transaction which is usually the repayment of a loan or a line of credit. There are many different types of Bank Guarantee such as in indirect and direct guarantees and others that represent differing transactions, some of which will be outlined below. It is essential to understand that receiving a Bank Guarantee is a simple process where the client (The Provider or Applicant), of the Issuing Bank, instructs the bank to transfer by swift, a Bank Guarantee to another bank (The Receiving Bank) favouring their client (The Beneficiary).
A most salient point to note is how Bank Guarantees (BG’s) differ from Standby Letters of Credit (SBLC’s) and Documentary Letters of Credit, (DLC’s) in regard to payment. A Bank Guarantee is used as SECURITY for a payment whereas Standby and Documentary Letters of Credit are utilised as a MEANS of payment.
Legal implications differ from country to country so it is important to understand that Bank Guarantees are legally governed by the country where the issuing bank is domiciled. As legal precedents are different in each country it is therefore imperative that each Bank Guarantee is studied separately.
A Bank Guarantee can have different formats, be utilised for different purposes, and can be issued by a third party. In the case of an Indirect Bank Guarantee, the issuing bank via instructions received from their client, may under certain circumstances request their correspondent bank to issue a Bank Guarantee on their behalf. A Direct Bank Guarantee as the name presupposes, is where one bank issues a Bank Guarantee direct to another bank. Another form of Bank Guarantee is the Performance Guarantee or Surety Bond which fundamentally differs from a Bank Guarantee as under the terms of a Surety Bond payment will be only made if certain criteria are met. However, with a Bank Guarantee, payment is payable on Demand.
To raise a line of credit or secure a loan, referred to as Credit Facility Guarantees the Collateral Transfer Facility is utilised, employing the use of Demand Bank Guarantees. The Demand Bank Guarantees have explicit wording and is governed by ICC Uniform Rules for Demand Guarantees (URDG 760) and are payable on FIRST DEMAND.
Bank Guarantees are being utilised more and more by companies wishing to access loans and lines of credit, commonly referred to as Credit Guarantee Facilities. Two companies will enter into a Collateral Transfer Agreement where one company, (knowns as the Provider), will transfer a Bank Guarantee to another company, (known as the Beneficiary).
The actual transfer of the Bank Guarantee will be via Swift, (“Society for Worldwide Interbank Financial Telecommunications”), a bank to bank financial messaging service as explained below.
In order for a Collateral Transfer Agreement to work, both the Providers’ and the Beneficiary’s banks (the Issuing Bank and the Receiving Bank respectively), have very important roles to play. Both banks will carry out due diligence to ensure the Collateral Transfer Agreement is adhering to international and local Financial Laws, and under the Terms and Conditions of the Collateral Transfer Agreement, the Issuing Bank will transfer a Bank Guarantee to the Receiving Bank for account of the Beneficiary.
The bank to bank platform utilised for this transfer is known as Swift, (“Society for Worldwide Interbank Financial Telecommunications”) and is used by banks and financial institutions globally. The Society for Worldwide Interbank Financial Telecommunications enjoys a world-wide membership, and both the Provider and the Beneficiary must make sure their banks are members before entering into a Collateral Transfer Agreement.
When the Issuing Bank transfers a Bank Guarantee to the Receiving Bank, it is normal for a Swift pre advise to be issued before the actual transfer occurs. Once the Receiving Bank has received the pre advice, they will Swift respond in kind confirming they will accept the Bank Guarantee. Upon receipt of the confirmation the Issuing Bank will duly Swift transfer the Bank Guarantee.