What is Bank Guarantee and How Does it Work?
Bank Guarantee is a guarantee given by a bank to its customers for the repayment of their debts. The bank provides security to the creditor in the form of a loan or overdraft facility from its own funds.
When a customer borrows money from a bank, they are usually required to provide security, which is usually in the form of assets such as property, shares or cash.
If the customer cannot repay the loan on time, the bank can take action to recover the money owed by selling off these assets.
This protects both the lender and the borrower as it removes any potential risk of loss and encourages borrowing by giving customers certainty that they will be able to repay their debt.
Types of Bank Guarantees:
Bank guarantees are a form of insurance, typically offered by banks to their customers. They provide a financial safety net in the event that the bank is unable to pay back its debts. The guarantee is usually provided for a set period of time, and can be letters of credit, cash collateral, or a deposit with the bank.
The guarantee provides reassurance to the bank’s customers, who may feel more comfortable conducting business with a bank that offers a guarantee. It also serves as an incentive for banks to maintain good credit ratings, as they may need to offer more favourable terms on loans and other transactions if they have a bank guarantee in place.
There are three main types of bank guarantees: Liquidity Guarantees, Asset Protections, and Market Risk Guarantees.
Liquidity guarantees protect against the loss of deposits due to unexpected withdrawals or sales of assets by the bank. Asset protections provide protection against default on loans or investments held by the bank. Market risk guarantees cover potential losses in value caused by movements in interest rates or stock prices.
Benefits of Bank Guarantees:
-Providing assurance to lenders that loans will be repaid
-Protecting creditors from potential losses if borrowers default on loans
-Helping to stabilize financial markets