Bank Guarantee :
Need for bank guarantee in the commercial and business world is almost inevitable. Bank customers in their business world are often required to furnish bank guarantee either in support of their financial strength or performance standards. In the absence of bank guarantees issued by a bank’s customers, they would have had to keep cash as a security. The third party who seeks a guarantee prefers a bank guarantee for obvious reasons of bank’s credibility and their capacity to take the risks of payment. Bank’s on the other hand, are in a position to evaluate the customer’s standing and assess the needs, as issuing a bank guarantee is often a part of overall lending by the banks. Banks earn sizeable income in the form of commission besides being able to expand business. In this unit we shall discuss the fundamentals about bank guarantee and their types. We shall ponder over the care and precaution banks need to take at the time of issuance and payment of bank guarantees.
Bank guarantee is a guarantee given by a bank to a third person, to pay him a certain sum on behalf of the bank‘s customer, on the customer failing to fulfill any contractual or legal obligations towards a third person.
The customer at the instance of whom bank guarantee is issued must have some commitment to fulfill certain obligations to a third party, for instance, a customer as a contractor may have to deposit earnest money equal to ten percent of contract sum with the Government department. Government department offer to accept a bank guarantee for the like sum in lieu of deposit of earnest money. The customer requests his bank to issue a bank guarantee favouring the concerned department. Bank guarantee for a specified sum is for a certain period of time; say for example, a year. If during this period, the customer (contractor) commits any breach of contract, the department can invoke the bank guarantee and demand payment of the sum guaranteed. This is an example of a situation where need for bank guarantee arises.
The obligation on the part of customer to the third party may be contractual or legal i.e., imposed by law. This commitment of the customer is guarantee by a bank and if the customer fails to honour his commitment the banker pays the amount it has promised to pay. Once the bank gives a guarantee then its commitment to honour the guarantee is absolute and binding. It therefore, prudent that a banker secures his position by insisting on a suitable margin or security before issuing a guarantee on behalf of his customer. Normally, for a known and creditworthy customer, banker issues bank guarantee with cash margin. For instance, for a bank guarantee of say Rs.5, 00,000 bank may demand 20 percent cash margin in the form of deposit. In this case, customer will deposit Rs.1, 00,000 and the deposit receipt for the sum will be handed to the bank. Costumer will affix his signature on the back of the deposited receipt by way of discharge. Bank will note its lien as ‘Lien to B/G 12/2014.
Sometimes, banks may demand 100 percent cash margin. For instance, for issuing a bank guarantee of say Rs.5, 00,000/- banker may demand a cash margin of Rs. 5,00,000 in the form of deposit. Commission on 100% secured bank guarantee will be lesser than that of other bank guarantees.
Where the sum of bank guarantee is on the higher side and the customer enjoys multiple credit facilities, banks may require the customer to offer mortgage of immovable properties.