What Is a Bank Guarantee? How They Work, Types, and Example

What Is a Bank Guarantee?

A bank guarantee is a financial backstop offered by a financial institution promising to cover a financial obligation if one party in a transaction fails to hold up their end of a contract. Generally used outside the United States, a bank guarantee enables the bank's client to acquire goods, buy equipment, or perform international trade. If the client fails to settle a debt or deliver promised goods, the bank will cover it.

Understanding Bank Guarantees

A bank guarantee is a promise by a lending institution to cover a loss if a business transaction doesn't unfold as planned. The buyer receives compensation if a party doesn't deliver goods or services as agreed or fulfill contractual obligations.

Non-U.S. financial institutions and intermediaries in countries such as Spain, the U.K., and elsewhere may more heavily rely on bank guarantees in commercial transactions. But sometimes, a bank guarantee may help an individual rent a property.

A bank guarantee may also be called a standby letter of credit or be referred to as a bond. Bank guarantees from a reputable institution can help you establish business relationships, increase your access to cash flow and capital, protect your business from losses, and set you up for international opportunities.

Another type of guarantee is the loan guarantee from the Export-Import Bank of the U.S. This guarantees creditworthy foreign buyers of financing for U.S. capital goods and services purchases. U.S. companies receive payment when the product is shipped from the U.S. to a foreign buyer.

Examples of Bank Guarantees

Here are several kinds of bank guarantees that cover various risks, including:

• Performance bond guarantee: Serves as collateral for the buyer’s costs if services or goods are not provided as agreed in the contract.
• Advance payment guarantee: Acts as collateral for reimbursing the buyer's advance payment if the seller does not supply the specified goods per the contract.
• Warranty bond guarantee: Serves as collateral, ensuring ordered goods are delivered as agreed.
• Payment guarantee: Assures a seller the purchase price is paid on a set date.
• Rental guarantee: Serves as collateral for rental agreement payments.
  

For example, the World Bank offers a bank guarantee program for projects. These guarantees provide commercial lenders security against payment default or failure to meet performance obligations by governments.

Bottom Line

Guarantees help protect international trade relationships by mitigating risks if a contract falls through, suppliers don't perform according to a contract's terms, or a buyer won't pay for goods. While bank guarantees are not common in the U.S., you should be able to get a similar guarantee via a standby letter of credit.