Bank Guarantee (BG)

What is Bank Guarantee (BG)?

Definition

A bank guarantee is a financial term used to refer to the agreement made between three parties—the bank, the beneficiary, and the applicant. The applicant is the one who seeks the guarantee from the bank, and the beneficiary is the one who holds the guarantee.

How Does Bank Guarantee Work?

When the applicant applies for a bank guarantee from a bank, the bank will then issue BG on the receipt of the applicant’s request. The receipt carries the guarantee amount of an underlying transaction or any other stated purpose targeted towards the beneficiary. Once the beneficiary receives the claim from the guarantor (bank), a BG invocation is declared.

A bank guarantee is an important tool in promoting international and domestic trades. In the case of foreign trade, a foreign BG will be required. A foreign BG includes another party besides the initial 3 parties. This extra party is known as a ‘correspondent bank’. A correspondent bank can be involved when a bank does not have its branch in a foreign country, here, the bank can issue a BG through a correspondent bank. Before then, the bank would first have to do its due diligence, and all necessary financial and business analysis before issuing the BG.

NB: After issuing a BG on behalf of a debtor, if the debtor fails to pay the debt the bank that issued the BG would have to pay for it.