What is a Bank Guarantee, how does it work and how much do they cost?
A Bank Guarantee is a legal and binding obligation to pay the beneficiary by the issuing bank. The issuing bank will pay when the applicant or provider fails in their fiduciary and contractual agreements.
The applicant or provider is the client of the issuing bank. The beneficiary is the beneficiary of the Bank Guarantee. The issuing bank issues the Bank Guarantee.
There are two types of Bank Guarantee,
The Financial Guarantee – guarantees payment to the beneficiary if the applicant fails to pay.
The Performance Guarantee – guarantees to cover losses incurred if the applicant fails to perform on the underlying contract.
How Do Bank Guarantees Work?
All Bank Guarantees are issued by banks upon instructions received from their clients. Bank Guarantees are issued on a daily basis both here in Switzerland and in the rest of the world. There are many different types of Bank Guarantees a few of which are outlined below,
Customs Guarantees – are issued when a company is importing goods for re-export. This guarantee is issued to cover customs duty in the event the goods stay in-country. They are also issued so a company may clear customs and pay later on an agreed date.
Performance Guarantees – guarantees the promised performance of the applicant on the underlying contract. The value of this guarantee is usually between 5% and 10% of the value of the contract.
Tender Guarantees – sometimes known as bid bonds protect the company offering the tender during the process of the tender. It also guarantees that a company winning the tender will abide by the terms and conditions of the underlying contract.
Payment Guarantees – cover a plethora of transactions. Essentially it guarantees that the seller or creditor will receive payment on a specified date. Such guarantees cover leased property rent payments and the reimbursement of bank facilities. They also cover payments for goods received, (when replacing a Documentary Letter of Credit). Basically, the Payment Guarantee can cover all accounts payable.
Bank charges for issuing Bank Guarantees vary from bank to bank. The rule of thumb is anywhere between 50 basis points and 5% of the value of the Bank Guarantee.
Utilising a Bank Guarantee for Monetisation Purposes
When a company wishes to monetise a Bank Guarantee it must utilise a Demand Guarantee. This bank guarantee will contain exact and precise wording designed specifically for monetisation. A Demand [Bank] Guarantee is governed by ICC Uniform Rules for Demand Guarantees, (URDG 758) and is payable on first demand.
Via Collateral Transfer facilities, Demand Guarantees can be “leased” from companies (called Providers) and are recognised as Hedge Funds, Sovereign Wealth Funds, and senior family offices. Demand Guarantees used in this way represent the medium of the investment made by the Provider to the Recipient.
The company ‘leasing’ the Demand Guarantee (the Recipient) can offer the instrument as collateral to a third-party lender, but only indirectly. The lender can then make a loan or line of credit to their client, the Recipient. These facilities are known as Credit Guarantee Facilities.
What is the Cost of ‘Loan Against a Bank Guarantee’?
The Bank Guarantee Provider will bear the cost of issuing the Demand Bank Guarantee. In order to access Bank Guarantee Funding the beneficiary will have to bear three sets of charges or costs. Currently this is in the region of 12 ½% – 13% in tota.
The first charge or fee is the cost of “leasing” a Demand Guarantee. This is known as the Collateral Transfer Fee which the beneficiary pays to the Bank Guarantee Provider. Currently this fee is around 6%, but can be higher depending on the investment grade of the issuing bank.
The second cost is the cost of borrowing for 1 year. This cost will be based on 12 months Libor or 12 months Euribor depending on the prevailing transaction currency. Obviously this can change from year to year due to the impact of market forces.
The third set of costs are administrative costs consisting of booking fees, due diligence fees, legal fees and arrangement fees. Sometimes the beneficiary will rollover the Demand Bank Guarantee into year two. In this case they will only bear the cost of the Collateral Transfer Fee and the cost of borrowing. IntaCapital Swiss do not levy administration fees, nor advance fees and are very competitive with booking fee charges.
Point of Interest
Many companies are struggling to obtain credit facilities in today’s markets. If you are one of those company’s perhaps you should investigate Collateral Transfer facilities and Demand Guarantees. They could easily refinance your company. For more information, please visit our facility page ‘Collateral Transfer & Project Funding‘.