The definition of a Bank Guarantee, is where a bank promises to cover a loss in the event a borrower or beneficiary defaulting on a financial obligation. The Bank Guarantee or Letter of Guarantee is issued by one Bank (The Issuer), on behalf of their client (The Applicant or Provider) to another Bank (The Receiving Bank), in favour of their client (The Beneficiary or Borrower). Issuing Banks invariably issue Direct Bank Guarantees which are issued direct to the beneficiary’s banker (The receiving Bank). In the case of Collateral Transfers, Demand Bank Guarantees are the prevailing instrument, (see below).
For more information on the Provider, please go to “Who are Providers.”
A commonly asked question is “What is the difference between a Bank Guarantee (BG), a Documentary Letter of Credit (DLC) and a Standby Letter of Credit (SBLC)”. The main difference is that both Documentary and Standby Letters of Credit are a Means of payment, whilst a Bank Guarantee acts as SECURITY for payment. However, when a Standby Letter of Credit is used for monetising or hypothecation, then it too becomes a security for payment.
Legally a Bank Guarantee is governed almost exclusively by the laws of the country in which the issuing bank is domiciled NOT the laws of the country where the beneficiary is domiciled. It is therefore imperative that laws pertaining to each Bank Guarantee must be studied separately to ascertain all the legal implications.
Demand Bank Guarantees
A Demand Bank Guarantee is specifically used for hypothecation or monetisation and it is governed by ICC Uniform Rules for Demand Guarantees, (URDG 758). Under URDG 758, the Demand Bank Guarantee contains specific, exact and unique verbiage, so any lending banker or third party lenders will be left in no doubt that a Demand Bank Guarantee has been issued so it may be used as security to raise loans and lines of credit, (often to referred to as Credit Guarantee Facilities).
For further information on URDG 758, please go to “URDG”
Standby Letters of Credit
The standard use for a Standby Letter of Credit is for Trade Finance transactions, where it is utilised as a payment of last resort. Two companies, the buyer and the seller, enter into a contract whereby the buyer instructs their bank, (The Issuing Bank), to open a Standby Letter of Credit in favour of the seller, and transfer the Standby Letter of Credit to the sellers’ bank, (The Receiving Bank).
If the buyer fails in their contractual obligation to pay the seller, under the terms and conditions of the Standby Letter of Credit, the seller will instruct their bank to claim the full amount owed from the buyer’s bank.
However, when a Standby Letter of Credit is used for hypothecation or monetisation, it is utilised in the exact same way as a Demand Bank Guarantee,(see above), and has the exact same verbiage as governed by ICC Uniform Rules for Demand Guarantees, (URDG 758).
For further information on URDG 758, please see under “URDG.”