Financial bank guarantee for international trade


Advantages of a bank guarantee as a financial instrument

Financial bank guarantee for international trade

Bank guarantee is an effective trade instrument. This instrument provides fulfillment of the seller’s obligations to the buyer. Previously not being particularly popular on the financial services market, today the bank guarantee expands the scope of application due to the positive experience of the state agencies application.

This financial instrument is a documented obligation of the guarantor bank, taken by the request of the client (principal). It provides payment of a particular sum by the bank to the principal (beneficiary) lender under stipulated conditions.

Often, a "guarantee" is confused with "warranty". In fact, the similarity between them is reduced to the obligation of the bank to issue a certain amount to the creditor of the principal in case of failure to fulfill the terms of the contract by the latter.

The main peculiarities of a bank guarantee are unilateral contracts, its autonomy and independence from the liabilities provided by it. Other pecularities include urgency and irrevocability. These qualities allow the bank to take a unilateral decision to cancel the obligations. Revocability and the transference of the guarantee obligations are stipulated for each particular bank guarantee issuance. Thus, this financial instrument is characterized by formalization of relations between the contractual parties.

Main advantages

The guarantee is not a free service: for its opening the bank will charge the borrower a certain percentage. However, its usage allows not to divert money from circulation, strengthens the business relations between the partners and provides new opportunities for their development.

The important advantages of the principal are the following:

  • possibility of deferral of payment for goods / services
  • possibility of business cooperation with municipal and government customers
  • opportunity to obtain trade credit from a supplier
  • possibility of issuing a bank guarantee without supplementary conditions
  • more favorable terms compared to bank credits
  • additional confidence in good financial standing of a supplier that is proven by the agreement of the guarantor bank to issue a guarantee if requested

The advantages of using this financial instrument for the beneficiary are as follows:

  • high of effectiveness of application in practice, which implies reliability and rapid implementation
  • risk allocation between the contractual parties
  • motivation of both contractual parties to timely and qualitative performance of these obligations
  • minimizing the risks for advanced and deferred payments

Parties involved in bank guarantee issuance

  • Guarantor. A bank or any other lending institution can perform the guarantor functions. Earlier the insurance companies also had the right to issue. In 2010, a law was passed and they were deprived of this opportunity. The intention of a bank or other lending institution to act as a guarantor is confirmed by the relevant document.
  • The Principal (borrower). Person who is a debtor in any credit obligations.
  • Beneficiary. Person who is a creditor of the borrower by contract obligations, provide by the issued guarantees.

The initiator of the credit relations with the opening of a bank guarantee from a legal point of view, is the principal. In practice, this initiative is most often caused by the beneficiary\'s request for the additional financial support for fulfillment of contractual obligations.

Various types depending on the intended purpose

  • Customs. Provides various payments to the customs authorities from the importing companies.
  • Tender. Provides fulfillment of the contractual obligations by the participant of a tender (competition). This type of guarantee is effective in minimizing the risk of nonfullfillment of tender conditions by the winner, as well as in the selection of the most trustworthy participants.
  • Payment. Provides payment obligations of the principal to the beneficiary, is unconditional and is typically used for the trade credit.
  • Chargeback. Provides partial or full refund of the advance payment to the buyer if the supplier fails to perform his contractual obligations.
  • Fulfillment of contractual obligations. Provides payment of the agreed sum to the importer if the exporter fails to perform the conditions of the contract or to execute them properly.
  • Repayment of a credit. Provides various lending operations.

As to the terms of payment of the guarantee amount to the creditor, unconditional and conditional guarantees are distinguished. The first type can be characterized by payments on the request of the creditor, and the second – payments done only if the documents that prove partial or complete failure of the borrower to perform his obligations are provided.

As the presence of mortgage or any other security, secured and unsecured guarantees are distinguished. The first envisage the presence of any security of the guarantee fulfillment in addition to the signing of the documentary bank liabilities.

Confirmed bank guarantee differs from unconfirmed by the presence of another loan, partially or completely covering the amount of the guarantee.

Guarantees characterized as direct, and counter-guarantee differs the fact whether the liability to the seller is by the guarantor bank, or, according to the request of the buyer, entrusts it to another bank / credit institution.

To ensure large transactions syndicated guarantee can be used, that envisages participation of several banks in the formation of the guarantee amount.

The principal of the bank guarantees issue

Bank guarantees with their simple application in trade have a rather complicated legal basis. Issu of the bank guarantees on the territory of the RF is regulated by the Civil Code of the RF, municipal and government contracts are regulated by the norms of the Federal Law 94-FL.

The bank guarantees are opened by the following scheme applied:

  • The principal’s official document with a request of guarantee provision.
  • The guarantor’s decision on the possibility of the guarantee issue.
  • Concluding a contract between the principal and the guarantor, aimed at regulating the relations between them.
  • Payment of the monetary reward to the guarantor by the principal for provision of guarantee issue services.
  • Issue of the guarantee to the principal with an indication of the sum, payment conditions, validity tern and the list of documents to be provided by the beneficiary.
  • Transfer if the guarantee to the beneficiary by the principal.

The beneficiary shall check the following information to be present in the guarantee:

  • on the eligibility of the guarantee issued by a specific guarantor
  • on the eligibility of signing the guarantee document by a specific person

Thus, the beneficiary shall assure of guarantor\'s reliability by reading his license.

How the amount is paid

  • In the event of a specified by a contract conditions, the lender can demand payment from the guarantor fully or partly. The requirement of payment takes the form of an official written document with the relevant documents mentioned in the warranty attached. The beneficiary must inform about violations / failure in performance of the terms of the contract by the principal before the guarantee expires.
  • The guarantor considers the application and other documents of the beneficiary, raising the criteria of formal compliance with the conditions of the contract and not interfering in the relationship between the principal and the beneficiary.
  • The reason for the refusal to pay the guarantee amount can be discrepancy of documents provided by the beneficiary or the expired period of guarantee validity. In this case the guarantor shall notify the beneficiary about the refusal to pay and the reasons of such refusal.
  • The guarantor informs both contracting partied about partial or complete fulfillment of a undertaken liability or about its termination. In the latter case the guarantee amount is not paid to the beneficiary. However, if the beneficiary repeats the demand, the guarantor must fulfill it.
  • Liability of the guarantor to the creditor is payment of a specific amount and no additional expenses, damages or fines can be added to it. After payment of the stipulated by the agreement amount to the creditor, the obligation of the guarantor is considered as fulfilled.
  • In the case of total non-performance or poor performance of the guarantor’s obligations to the exporter, the latter may bear losses and additional expenditures. This can happen if the guarantor has not done the comparative check and consideration of the documents from the beneficiary within a reasonable period. Then refund of the losses to the beneficiary is mandatory from the guarantor.
  • After payment of a specified amount to the beneficiary, the guarantor has the right to demand the return of this amount by the principal under the conditions mentioned in the agreement. This agreement is designed to determine the amount and timing of the property damages, conditions for exemption of the borrower from liability to the guarantor etc. However, the guarantor has no right to demand compensation of expenses incurred as a result of unfair performance of obligations from the borrower to the supplier.

The guarantee shall expire immediately after the guarantor\'s payment of a certain amount to the seller, or the expiration of the designated period. There are other cases of closing. As an example, lack of possibilities to perform the obligation, the identity of the beneficiary and the guarantor and the receipt of a counter claim. In any case, the guarantor shall promptly notify the borrower about the closing of this guarantee.

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