Bank Guarantee (BG)

What is a Bank Guarantee?

A Bank Guarantee (BG) is a financial promise issued by a bank that ensures a business will meet its contractual or financial obligations. If the business fails to fulfill its duties, the bank steps in and covers the financial loss up to the agreed-upon limit. This instrument is commonly used in international trade, large-scale projects, and investment deals to provide security and mitigate the risk for the parties involved.

How Does It Work?

In a typical scenario, if a company (the borrower) enters into an agreement with a supplier (the lender), and the supplier is concerned about receiving payment, the borrower might request a bank guarantee. This BG would act as collateral, assuring the supplier that if the borrower defaults, the bank will cover the payment.

For example, if a construction company is awarded a project, the contracting party may require a performance guarantee from the company’s bank. This guarantee ensures that the bank will pay if the construction company does not deliver the project according to the agreed terms.

BG as Collateral for Loans

A Bank Guarantee can also be used as collateral for loans. For instance, if a company needs capital for expansion or working capital and doesn't have enough cash reserves or assets to pledge, they can provide a BG. The bank guarantees the repayment of the loan, making the lender feel confident that they will get their money back if the borrower defaults.

By offering a BG as collateral, the borrower gains access to financial support without having to liquidate assets, which can be crucial for businesses looking to preserve their working capital or strategic resources. The bank, in turn, gets assurance that if the borrower defaults, it will step in to cover the financial obligation.

Fresh Cut BG vs. Leased BG

• Fresh Cut Bank Guarantee: A Fresh Cut BG is an original and newly issued guarantee. These are typically used by businesses that need to access large sums of money or secure major projects. A fresh cut BG is particularly attractive because it is issued specifically for a particular transaction and is highly valued by investors, as it provides a direct guarantee from a reputable bank.

• Leased Bank Guarantee: A Leased BG, on the other hand, refers to an instrument where a business rents a bank guarantee from a third-party provider. While it may offer the same functionality as a fresh cut BG, it is not issued directly by the business, but rather borrowed or leased. This is often a more cost-effective option for companies that need the security of a BG but do not want to bear the costs of obtaining a fresh cut guarantee.

How Investors Feel Safe Using BG as Collateral

For investors, using a BG as collateral offers a significant layer of security in high-risk deals. Since the bank is the guarantor, the investor can be confident that even if the borrower defaults, the financial loss will be covered. This makes BGs particularly attractive in sectors with a high level of uncertainty, such as construction, international trade, and large-scale infrastructure projects.

In many cases, investors prefer BGs because they provide a non-recourse option to recover their funds, meaning the lender does not have to chase the borrower for repayment. Instead, the bank assumes responsibility. This assurance reduces the risk of the investment, allowing investors to engage in projects they might otherwise avoid due to potential financial risk.