Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Bank Guarantee

What it is:

A bank guarantee is a promise from a bank or other lending institution that if a particular borrower defaults on a loan, the bank will cover the loss. Note that a bank guarantee is not the same as a letter of credit.

How it works (Example):

Let's assume Company XYZ is a small, relatively unknown restaurant company that would like to purchase $3 million of kitchen equipment. The equipment vendor may require Company XYZ to provide a bank guarantee in order to feel more confident that it will receive payment for the equipment it ships to Company XYZ.

To obtain this bank guarantee, Company XYZ requests one from its preferred lender (usually the bank with which it keeps its cash accounts). The lender provides the guarantee in writing, which is then passed on to Company XYZ and its vendor. Company XYZ's lender essentially becomes a co-signer on the purchase contract with the vendor.

Why it Matters:

A bank guarantee enables companies to make purchases that they would otherwise not be able to make; these guarantees thus serve to heighten business activity and expand entrepreneurial activity.