When you apply for a loan with a lender, it may ask for collateral or security. This collateral acts as a guarantee that you will repay your loan. Sometimes, you may have to put forth a guarantor who takes the responsibility of repaying your loan if you’re unable to do so. A Bank Guarantee acts similarly. It offers surety and a guarantee to the lender on behalf of their customers.
Continue reading to know more about a Bank Guarantee, how it works, and what may happen if it expires.
What is a bank guarantee?
A Bank Guarantee is a trade finance instrument issued by banks and Non-Banking Financial Corporations (NBFCs) to ensure that the liabilities of the customers are met. In other words, it is a promise or security provided by a bank or an NBFC that if their customer fails to Perform or repay as per terms of agreement, then the bank or the NBFC will take care and pay as per demand letter.
Bank Guarantees are generally used between business entities. With the help of a Bank Guarantee, you can purchase raw materials, equipment, machinery and acquire funding for your business. When a bank or an NBFC issues a Bank Guarantee, it promises to pay the debts of its customer on whose behalf guarantee is issued.
How does a Bank Guarantee work?
A Bank Guarantee acts as an insurance policy or security for the Beneficiary of guarantee. Here are the steps in which a bank guarantee works:
- The applicant needs to apply for a Bank Guarantee with the bank or NBFC. The bank may ask for margin money or collateral to issue a Bank Guarantee
- The bank or NBFC then issues a Bank Guarantee on behalf of the Customer on Stamp paper as per Indian Contract Act
- The Customer needs to deposit this Bank Guarantee with the Beneficiary as per their business terms to fulfill their terms
- In case the Customer defaults to perform as per business terms or as per agreement between 2 parties, the Beneficiary may file a claim with the bank against this Bank Guarantee
- The issuer bank or NBFC will have to Pay as per terms of Guarantee on behalf of customer (which is the borrower in this case)
What happens when a Bank Guarantee expires?
Bank Guarantees are issued as per the Uniform rule of Demand Guarantees (URDG) 758 issued by the International Chamber of Commerce or under the local laws of the country. In India, a Bank Guarantee is issued as per the Contract Act 1872 and is abide by Limitations Act of 1963. As per this act, Bank Guarantees must have a limitation period, and the claims can be made on them only within this period.
Usually, the limitation period for Bank Guarantees in India is 12 months over an above Expiry date of bank Guarantee If a claim is not filed on a Bank Guarantee within this period, it expires.
A Bank Guarantee expires under one of the following conditions:
- It is not invoked within the validity Period of guarantee
- When no amount is payable under a Bank Guarantee by the issuing bank or NBFC
- If the original Bank Guarantee is surrendered to the issuing bank or NBFC along with discharge letter
- When the beneficiary releases the Bank Guarantee
After the expiry of a bank guarantee, the issuing bank or NBFC is not liable to pay anything to the beneficiary even if the borrower defaults on his or her loan thereafter. The original Bank Guarantee needs to be returned to the issuer after its expiry, and if an issuer doesn’t get its Bank Guarantee back after its expiry, it may write a registered letter to the beneficiary to get the original Bank Guarantee certificate.
After receiving the original Bank Guarantee certificate, the issuing bank or NBFC cancels it and returns the margin money or collateral to the applicant.
In case a customer wishes to extend the validity of the Bank Guarantee, he or she needs to inform the issuing bank or NBFC about it. After receiving the extension request from the Customer, the issuer extends the Bank Guarantee’s validity and sends the Extended Bank Guarantee certificate to the beneficiary. Some banks even put an essential clause in their Bank Guarantee for an automatic extension of its validity period.
Also read: Your guide to Credit Guarantee Trust for Micros and Small Enterprises
Looking to apply for a letter of credit and ban guarantees? Click here to get started and locate the closest bank branch near you now!
*Terms and conditions apply. The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances.