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What is a Bank Guarantee?

When a lending institution offers a Bank Guarantee, they are reducing the risk involved in a transaction by guaranteeing payment to the seller.

Bank Guarantees often come into play with deals made internationally, where the participants in the deal prefer to have some assurances before they do business. The guarantee acts as insurance to protect the parties involved in transactions where they are not fully able to assess the strength and reliability of the other, such as when small companies bid for projects or when bids for a job come-in from around the world.

With a Bank Guarantee, the bank does the vetting, and the company who will expect to be paid only has to know the strength of the bank. These can be performance guarantees or financial guarantees. The bank stands by as ‘Surety’ and charges fees based on the guaranteed amount.

To note: a Bank Guarantee is not a Letter of Credit, which is also used internationally. A Bank Guarantee is only called-in if the opposing party in a transaction cannot pay or provide what was agreed upon.

A Letter of Credit, on the other hand, actually facilitates the transaction by serving as the method of payment when the transaction is complete.

Keywords: insurance, international trade, letter of credit, banker's acceptances, surety, bank guarantee,