What is Bank Guarantee? - Different Types of Guarantees
The scope of trade has been widely expanded in the modern world. There are many kinds of organizations, private and public which trade with each other. A lot of the time, trades happen between big and small organizations and sometimes these trades happen when both parties are present in different countries. In such cases, there is a likelihood that the business owner will be exposed to different types of credit risks. The presence of these credit risks has provided commercial banks with an opportunity to expand their business and provide more value-added services to their customers.
A Bank guarantee is a type of banking product that is offered by commercial banks to help their customers deal with the problem of credit risks. In this article, we will understand what a bank guarantee is and what are the different types of bank guarantees offered by commercial banks.
What Is a Bank Guarantee?
In order to understand the concept of bank guarantee, we first need to understand the concept of credit risk. Whenever one party provides goods or services to another party on credit, there is always a risk of non-performance involved. It is quite possible that businesses might not be comfortable in undertaking a contract given the credit risk profile of their counterparty.
Banks, in general, tend to have a considerably high credit rating as compared to common financial counterparties. Hence, if the banks were to guarantee the execution of a contract by co-signing it, the chances of non-performance are reduced drastically. This is what the concept of a bank guarantee is all about.
When a bank provides a bank guarantee, it assumes the credit risk of the entire transaction. The bank is guaranteeing the beneficiary that if the corporation is not able to execute the transaction, then the bank which is a much larger and more powerful financial body will execute the transaction on their behalf.
In return for providing this credit guarantee, banks are able to charge a significant fee. Also, since banks have good visibility of the financial position of the company that they are providing the guarantee for, they are taking a calculated risk. If the bank feels that the corporation is not creditworthy, then they might ask for collateral before they issue a bank guarantee.
Types of Bank Guarantees
There are various types of bank guarantees which are provided by commercial banks to their corporate clients. Some of the most commonly used types of bank guarantees have been mentioned below:
The fact of the matter is that bank guarantees are a very important part of a commercial banking system and will continue to remain so. They are an important tool used by banks to attract corporate customers to use their services.
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