A Bank Guarantee is a type of financial backstop issued by a lending institution to a borrower. Guarantees are typically required when the bank or lender has doubts about the borrower’s ability to repay the loan. Guarantees are most commonly used in business-to-business transactions, such as corporate loans. Although there are several types of guarantees, all of them are designed to ensure that the lender is repaid if the borrower does not pay back the loan.
A bank guarantee is similar in many ways to a letter of credit. Both are forms of credit enhancement that are used in lieu of collateral or when the collateral itself is not sufficient. However, a letter of credit is typically issued by a bank or other financial institution, whereas a guarantee is issued by an insurance company, a third-party guarantor, or directly by the borrower.A letter of credit is designed to protect the interests of the lender, whereas guarantees are designed to protect the interests of the borrower. The two instruments serve similar functions, but they do so in different ways. In addition, guarantees can be tailored to meet the specific needs of each borrower.There are two basic types of guarantees. The first type , known as a standby letter of credit, is issued by a bank or other financial institution in favors of the lender. The second type is called a direct guarantee, and it is issued directly by the borrower to the lender.As with letters of credit, guarantees are usually issued on a short-term basis (usually less than one year), although longer-term guarantees can be issued.
