A promise by a bank to cover a financial obligation if the borrower (applicant) fails to fulfill their contractual duties.
A Bank Guarantee (BG) is a commitment from a bank that if the applicant defaults on payment or performance, the bank will pay the beneficiary. Unlike a loan, money isn't disbursed upfront — the bank only pays if the applicant fails. Types include Performance Guarantee (ensuring project completion), Financial Guarantee (ensuring payment), Advance Payment Guarantee, and Bid Bond. Banks charge 0.5%–2.5% annually on the guarantee amount and require collateral or margin money.
A construction company needs a ₹50,00,000 performance guarantee for a government contract. Bank charges 1.5% p.a. for 12 months. Cost: ₹50,00,000 × 1.5% = ₹75,000 + ₹5,000 processing fee. If the company fails to complete the project, the bank pays ₹50,00,000 to the government.
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A Bank Guarantee is a safety net — the bank pays only if the applicant DEFAULTS. A Letter of Credit is a payment mechanism — the bank pays the seller upon receiving specified documents regardless of buyer's default. BG protects against non-performance; LC facilitates trade payment.
Yes, as a Contingent Liability (off-balance sheet note) since it represents a potential future obligation. If the guarantee is invoked, it becomes an actual liability. The margin money/collateral deposited appears as a restricted asset.
A written guarantee from a bank (on behalf of the buyer) promising payment to the seller upon presentation of specified documents proving shipment of goods.
A credit facility where a bank allows a business to withdraw more than its account balance up to an agreed limit, charging interest only on the amount overdrawn.
A potential financial obligation that may arise depending on the outcome of a future uncertain event, such as a pending lawsuit or warranty claim.
The use of borrowed funds (debt) to finance business operations, amplifying both potential returns and risks for equity shareholders.
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