What is Bankers Guarantee?

A Bankers Guarantee (BG) is a definite undertaking by the bank

(guarantor) to pay the beneficiary a certain sum of money
within a specified period if the beneficiary submits a demand for
payment under the guarantee. It is normally used to secure
either a financial or performance obligation of the principal.
Guidelines for Issuing Bankers Guarantee
A Bankers Guarantee should bear all the six following
characteristics:1. CAP ON MAXIMUM LIABILITY
To protect the interests of both the principal and the guarantor,
there must be a cap on liability up to the maximum guaranteed
sum.
2. CONTAIN A DEFINITE EXPIRY DATE
A Bankers Guarantee should have a definite expiry date unless
1. It is issued as a continuing guarantee, such as the ones
issued in favor of Controller of Transport for issuance of Travel
Agency License, or
2. It is issued in connection with a court case, which is
renewable on yearly basis until disposal of the suit, or
3. It is issued in favor of Collector of Customs for presentation in
lieu of duties payment. These guarantees, though, have a
definite expiry date but are construed to exist beyond their
expiry date due to an indefinite claim clause in Customs Act.
Absence of a definite expiry date would create uncertain
duration of liability for both the principal and the guarantor.
3. DEFINITE CLAIM PERIOD
Bankers Guarantee should have a definite claim indicating the
latest date that a claim can be submitted. Absence of a definite
claim period would subject the principal and guarantor to a
claim of up to six years.
4. PAYMENT ON DEMAND
A Bankers Guarantee shall effect payment on demand by the
beneficiary giving a written statement that the principal has
failed to perform his obligations. Such written statement will be

the sole condition for the guarantor to pay under the guarantee.
The guarantor will not take additional steps to determine any
facts or documents relating to the underlying contract or to
verify appropriateness of the claim.
5. PROHIBITION AGAINST ASSIGNMENT
A Bankers Guarantee shall not be assignable due to the
following reasons: To avoid the bank losing its right of set-off vis--vis the
beneficiary
To avoid the bank paying to the wrong party
To reduce administrative uncertainties if there are multiple
assignments made
If a Bankers Guarantee is silent on assignment, it can be
assigned by the beneficiary. In view of the above-mentioned
prohibition, BG issued is usually on a non-assignable basis.
6. GOVERNING LAW & JURISDICTION
Local law should be stated as the governing law of the BG
issued by banks and the beneficiary should submit to the
jurisdiction of the reference countrys courts. It would be
expensive and time consuming if an action is brought against
the bank in a foreign jurisdiction and under foreign law.
Collaterals against Guarantees Issued
Banks secure themselves for guarantees issued on account of
applicant in two ways:
1. Through cash margins, and / or
2. Through charge on applicants movable and immovable
assets
Cash margins are obtained either in cash over the counter or
debited to customers account and credited to the Margin
Account Guarantees. Hence, this amount is set aside for any
future claim that is received from the beneficiary under the
guarantee issued by the bank.
In case of charge on movable and/ or immovable assets of the
applicant, no financial transaction takes place. Merely charge is
registered, such as property mortgaged, stocks and receivables

hypothecated, stocks or certificates of deposits pledged, etc.

Counter guarantee given by Applicant
Counter guarantee is an indemnity provided by the applicant to
the issuing bank indemnifying it for any payments that it would
make under the guarantee issued on applicants request. Banks
use standard counter guarantee forms for this purpose.
Text of bank guarantees
The text of guarantee is provided by the beneficiary of and is
checked and customized by the issuing bank for the 6 points
mentioned above

Guarantee commission
Banks charge commission on guarantees. Normally these are
quoted in tariff as per quarter. This commission ranges between
1.6% to 2% p.a. (0.4% - 0.5% per quarter). Banks normally
recover commission for the entire tenor of the guarantee of the
tenor is less than 1 year, or 1 full year if the guarantee is valid
for more than 1 year.
Payment by issuing bank under guarantee
Bank guarantees are unconditional, first demand guarantees.
Whenever a demand is received by the bank from the
beneficiary under its guarantee, it is bound to honor it, subject
to:
1. Claim is made by the beneficiary of the guarantee
2. Claim is received within the expiry date of the guarantee
3. Sum claimed is equal to or less than the total sum
guaranteed
4. If the guarantee is expired claim is made within the validity of
claim period, if any.
Payment mechanism
GUARANTEES COVERED BY CASH MARGIN:
Payment under guarantees covered by cash margins is very
easy. Bank would debit the margin account guarantees and

issue a draft or payment order in favor of the beneficiary and

notify applicant of this transaction. Before payment, bank would
obtain a discharge from the beneficiary on original guarantee
paper.
GUARANTEES COVERED BY CHARGE ON MOVABLE /
IMMOVABLE ASSETS:
In this situation, bank doesnt have applicants liquid funds
available for use in payment to beneficiary. Bank would create a
forced loan be debiting loan account in the name of the
applicant and issue a draft or payment order in favor of the
beneficiary and notify applicant of this transaction. Before
payment, bank would obtain a discharge from the beneficiary on
original guarantee paper.
Bank, then would make a demand on applicant for adjustment
of loan created along with markup.