Banks Do Not Warranty, They Guarantee

You will find banks extending guarantee, but not warranty

. A warranty, being a strict legal contract, is much riskier for the bank to extend. Bank guarantees are however common legal financial instruments for securely carrying on overseas transactions. A bank guarantee is issued by the bank only when the bank is sure of the financial health of the company as is evident from its account at the bank. There is a limit to the amount that the bank will guarantee and there is also a limit on the number of times a bank will extend guaranteed financial services on behalf of the company. However, despite these limitations, a bank guarantee is a highly effective trade finance option for especially carrying on overseas transaction. The buyer usually demands the guarantee and the seller acquires it, on demand, from the bank. The two parties involved in transaction may also require other financial instruments. The letter of credit is one such instrument.

Financial services of the bank

Every business transaction requires the intervention of the bank, directly or indirectly. The responsibility of the bank is to see that the guarantee is extended according to the financial health of the seller. The bank checks the financial health according to different parameters to be sanguine about the reasons to extend its guarantee on behalf of the seller. Bank guarantee and letter of credit are two financial instruments that are frequently used by the bank instead of other riskier practices like open account or advance payment.

Types of bank guarantees

Various types of bank guarantees exist. There is a type called bid bond guarantee, which is asked by the buyer when multiple companies have applied for the tender and are in the fray for winning the project. The bid bond guarantee ensures that only serious bidders are applying for the tender. Then there are milestone guarantees and advance payment guarantees both required at different stages of a business transaction. In the guarantee system, the company has to prove its credit worthiness to a reputable bank, which will act as a guarantor on its behalf.

Types of letter of credit

There are four main types of letter of credit. The commonest type is of course the confirmed letter of credit. Other variants of the LC are revocable letter of credit, irrevocable letter of credit, Sight letter of credit, and future letter of credit. About revocable and irrevocable letter of credit, it must be mentioned in the letter whether the it can be revoked or not by the seller. However, for best reasons, buyers are always suggested to stress on irrevocable letter of credit, as those are much less risky. The future LC is also known as credit LC.

by: SB Public Relations

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