Term
Bank guarantee
A written undertaking by a bank to perform if the client does not. A tender client or a landlord typically asks for one instead of a cash deposit.
Updated
What it means
A bank guarantee is the bank’s own undertaking to pay the beneficiary a stated amount if the client fails to perform. The bank does not examine the underlying dispute; it pays on the wording of the guarantee.
For a company it is cheaper than depositing the same sum in cash: the money stays in the business and only a fee is paid. The bank, though, counts it against credit exposure and asks for security.
A guarantee differs from a letter of credit in purpose. A letter of credit is a payment tool: the bank pays the supplier on presentation of documents proving proper delivery. A guarantee is security: it pays only when something fails, and on a properly performed contract not a single euro leaves under it. The company is paying for the bank’s readiness, not for moving money.
How it works in practice
It is most often required by a client in public procurement, by a landlord instead of a deposit, or by a customer in place of retention money on a construction contract.
In the books it is not a liability until it is called: it sits in off-balance-sheet records and in the notes. The bank’s fee is a financial cost of the period.
When a client needs a guarantee we prepare the bank pack: the latest financial statements, interim results, a list of existing loans and a cash flow outlook. The bank assesses a guarantee much like a loan, and approval takes days to weeks. It pays to start well before the tender submission deadline comes into view.
What to watch out for
The gap between an on-demand guarantee and a conditional one is decisive. Under the first the bank pays on a simple demand and you litigate afterwards to get the money back, not to stop it leaving.
A guarantee has an expiry date and the bank charges its fee for as long as it runs. If the job finishes early, get a written release or the original guarantee back from the beneficiary and hand it to the bank; otherwise the company keeps paying for security nobody needs. The opposite problem arises when the job runs late and the guarantee expires before handover.
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