Bank guarantees are frequently used in international trade finance as a means to reduce risk. They can be simply defined as a promise by the bank to cover a loss in the event of either a buyer defaulting on payment or a seller failing to supply goods as agreed; depending on how the bank guarantee is drawn up.
As a result, bank guarantees can provide virtually complete risk mitigation to exporters. They can also be used to protect importers, when drawn out as such. Note, however, that a single bank guarantee does not work both ways and will cover only one party. Thus, where two-way risk mitigation is required more than one bank guarantee is required, which is why more efficient mechanisms, such as Letters of Credit, are often used instead in such circumstances.
Common Types of Bank Guarantees in Trade Finance
Bank guarantees are used in many transactions and not only in trade finance. However, when it comes to import/export trade, these are the most commonly used forms:
Payment Guarantees – These instruments ensure that the exporter will receive payment on a specific date; some may have additional conditions included and may be revocable in some instances.
Confirmed Payment Orders – These are irrevocable and the bank must pay the exporter a specified amount on a specific date.
Performance Bonds – These bank guarantees are more complex and allow the importer to recover incurred costs if goods are not provided as contractually agreed upon.
Advance Payment Guarantee – This is a bank guarantee used to ensure that the importer will be reimbursed for any advance payments made in respect of the transaction, if the goods are not delivered as agreed.
Simple Working Examples
Suppose a new company in the UK wants to import tea from a major exporter in India, but the Indian exporter is not familiar with the UK buyer. In this case, the exporter may ask for a payment guarantee, just to be sure, which will provide them with the confidence and security to make the shipment as per the buyer’s requirements, without worrying about a potential default.
Alternately, suppose a small exporter from a country in Africa is trying to supply some goods to the EU, but requires an advance to be sure of the buyer and also to fund working capital needs. In this case, the importer may ask the small African company to provide an advance payment guarantee to mitigate the risk of non-performance.
Choice of Bank is Important
When looking to use a bank guarantee, your choice of trade finance partner is important. Always look to work with a reputed international bank that is welcoming to SMEs, such as Euro Exim Bank. Our team of experts, wealth of experience and specialization in trade finance make us an ideal choice. We also use cutting-edge digital technology to provide next-gen services such as digital bank guarantees, which are faster and often more economical that traditional methods.
