Bank Guarantees and Bonds are both considered to be financial instruments that act as sureties to protect the parties who enter into contracts for the exchange of goods and services. These instruments provide a guarantee to the purchaser that in case of failure by the seller, they can impose the contractual obligations to be fulfilled.
Bank Guarantee vs Bonds
The main difference between a Bank Guarantee and a Bond is that to obtain a Bank Guarantee there is a requirement of collateral to satisfy the bank, while Bonds do not need collateral to act as a surety.
A Bank Guarantee is often given along with a loan as a provision that if the borrower fails to repay the amount, the bank will cover the losses. While a Bond acts as a surety against one of the parties who agree, from breaking it.
Bank Guarantees also known as a letter of credit, ensure that payments between the seller and buyer go smoothly, whereas Bonds also known as surety bonds protect the parties from the risk of broken contracts.
Comparison Table Between Bank Guarantee and Bonds (in Tabular Form)
| Parameter of Comparison | Bank Guarantee | Bonds |
|---|---|---|
| Meaning (Definition) | A bank guarantee is when a lending institution like a bank stands as a guarantor and promises to cover the losses in case the borrower fails to do so. | A bond can be considered to be a deal or agreement between the lender and borrower that acts as a surety of payment for either of the parties. |
| Issuers | A bank guarantee can be issued only by a bank as surety for some individuals. | Bonds can be issued by banks, government or even large companies to meet their large needs of money. |
| Route of payment | In the case of a Bank Guarantee, the payment has to always go from the seller to the buyer through the bank. | In the case of bonds, the bank does not need to pay the bondholder and can keep its fee, if there are no failures in payment. |
| Accounting | A Bank Guarantee is always considered to be a liability for the bank as it is a kind of obligation on the bank to pay it out. | A bond is a kind of an insurance product and therefore accounted for as an asset, as long as the transaction goes smoothly. |
| Users | Bank Guarantees are used by individuals for safer International and cross-border transactions, which helps businesses grow. | Bonds are usually used by governments and corporations to borrow huge amounts of money. |
What is Bank Guarantee?
A bank guarantee is a kind of promise provided by a bank or maybe any financial institution to a particular lender, that if the borrower fails to repay the borrowed amount, the bank will act as a guarantor and take care of all the losses on behalf of the borrower.
Bank guarantees are usually used by business entities and this allows them to purchase equipment, raw materials, machinery, etc. with a surety that even if the borrower is not able to pay back the amount, the bank will stand accountable for it.
Bank Guarantees are usually highly-priced in nature and are valid for a longer time. They can turn out to be risky for banks as by signing a bank guarantee, the bank agrees to pay whatsoever amount that is requested by the borrower.
There are different kinds of Bank guarantees:
Deferred Payment guarantees:
As the word cites, these guarantees are issued for a certain fixed period and are usually given out to exporters. In case of failure, the bank has to provide the amount in installments.
Financial Guarantee:
These kinds of guarantees are made with the condition that the bank will repay the party if there is any delay in the completion of the project or if it is not completed entirely.
Advance Payment Guarantee:
Advance payment is made to the service provider with the hope that he will be able to provide his services on time. But if that is not done, these guarantees ensure that the buyer gets a refund of his payment.
Performance Guarantee:
These guarantees are usually made based on the performance of a certain service, wherein delay in performance or inadequate service by the dealer leads to the bank paying amounts.
Foreign Bank Guarantee:
These guarantees are usually similar to the normal guarantees except for the fact that these are offered on behalf of a foreign beneficiary or creditor.
What are Bonds?
A bank bond or surety bond is a kind of contract between three parties, i.e. the principal (the borrower), the surety (the bank or any financial institution) and the obligee (the lender), where the surety stands as a guarantee to the obligee that the principal will fulfill all the terms of the bond.
Bonds ensure that the contract entered by the parties works smoothly and is completed according to the terms they have mutually agreed upon. They protect the governments and consumers from fraud, misinterpretation, and malpractices, thus allowing businesses to flourish.
Although the bank or organization acting as a surety backs the bond and covers up in case of losses, the principal is required to sign an indemnity agreement known as a general agreement of indemnity which includes all the businesses done by the principal along with its owners.
Some of the types of bonds are as follows:
Contract Surety Bond:
In these bonds, the principal is usually a project owner, and the bond guarantees that a contractor will follow every specification laid out in a contract and pay for all the expenses of his workers.
Commercial Surety Bond:
These kinds of bonds are usually mandated by government agencies and are used to protect the public interest. Here the oblige is the general public.
Fidelity Surety Bond:
These bonds usually protect a company from the malpractices or frauds done by employees who handle cash and finance departments. They are a kind of protection against people’s money and personal assets.
Court Surety Bond:
These kinds of bonds are usually required by lawyers or attorneys before court proceedings to ensure they get their court fees and also to protect them from any kind of losses.
Main Differences Between Bank Guarantee and Bonds
- A Bank Guarantee is considered to be a way to transfer payment between the lender and the borrower, while Bank or surety bonds provide a kind of insurance against either of the parties to a contract from breaking it.
- Bank Guarantees are usually to be paid at the time the borrower fails to make the payment while a bond is issued with a maturity date and has to be paid on the end date along with interests.
- Bank Guarantees are usually on demand, whenever the lender wishes to receive his money and the borrower is unable to repay, while Bonds are conditional, i.e. have a lot of conditions attached to it.
- The main difference between Bank Guarantee and Bonds is that in a Bank Guarantee the transfer of money is not directly from a buyer to the seller, but through the bank that acts as a guarantee, while in a Bond the transaction takes place directly between the parties, if there is no failure on the side of the borrower.
- A Bank Guarantee is usually liable for the financial risk of the contracted project, while a Bond is liable for any performance risk posed by the principal.
Conclusion
Bank Guarantees and Bonds act as instruments in the financial sector providing assurance and protection to those who lend out as well as receive money.
In the case of a bank guarantee the bank always comes into the picture, even when there is a failure or not of the payment, while in case of bonds, if the transactions go well between the parties, the bank can keep its fee and stays under no obligation.
Though both these instruments have different functions, they ensure safe contracts and transactions between parties.
References
- https://www.manchesterhive.com/view/9781847799913/9781847799913.00016.xml
- https://www.econstor.eu/handle/10419/168912