How Surety Bonds Are Different From Bank Guarantees?
Difference Between Bank Guarantee And BondsBoth bank guarantees and bonds are considered some of the most important types of financial instruments that provide payment security to protect the parties entering into the contracts for the exchange of goods & services. These instruments assure sellers that they would be paid on time by the buyer. So what is the difference? Let’s start by understanding their meaning.
What is a Bank Guarantee?1. A bank guarantee is a legal promise made by the issuing bank or financial institution to the particular seller/supplier that if the borrower/applicant fails/defaults to pay or perform the terms & conditions mentioned in the BG contract, the bank will act as a guarantor and cover the full or remaining amount of debt on behalf of its borrower.
2. BGs are one of the most frequently used trade finance instruments by business entities to initiate purchase equipment, raw materials, machinery, etc, with an assurance of on-time payment even if the borrower is not capable of paying the amount back.
3. When the transaction is complete between the trading parties, the seller can present the document to the bank and receive payment.
4. Bank guarantees establish trust between the trading partners who don’t know each other due to cross-border transactions.
What Is a Bond?1. Unlike a bank guarantee service that ensures that the sellers get on-time payment in case if the borrower defaults, a surety bond or bank bond is a financial instrument created to protect the parties involved in a contract from the risk of a failed/broken contract.
2. For example, a corporate owner wants an interior company to redesign their office but is concerned that the interior company might not follow their requirements. So the owner might buy a surety bond from his bank. In case if the interior company fails to deliver, the bank will pay the owner a predefined amount of money as compensation. Similarly, the interior company can also buy a bond to secure their payment risks.
3. A bank bond or a surety bond is a legal contract between three parties - the principal (the borrower), the surety (A bank or financial institution), and the obligee where the bank assures a guarantee to the obligee that the terms & conditions of the bond will be fulfilled by the borrower.
Bank Guarantees VS Surety BondsHere are the key points of differences between bank guarantees and surety bonds. Let’s have a look:
1. Requirement of Collateral - The very first and foremost difference between a bank guarantee and a surety bond is that there is a requirement of collateral by the issuing bank in case of a bank guarantee. On the other hand, bonds do not require any collateral.
2. Type of Issuance - A bank guarantee is issued with a loan along with a provision that if the borrower fails to repay the amount, the bank will cover the loss while a surety bond is issued to protect parties from a broken contract.
3. Issuers - Only the banks or financial institutions can issue a bank guarantee while bonds are issued by banks as well as governments or even big companies to raise money.
4. Mode of Payment - In the case of a bank guarantee, the payment is done through the bank while in case of bonds, the banks are not required to pay the bondholder and charges a fee, if there are no defaults in payment.
5. Liability of Bank- A bank guarantee is considered as a liability for the bank guarantee service providers as the bank is responsible for paying to the seller. While in surety bonds, it is a type of insurance product and thereby it is considered as an asset provided the transaction goes as planned.
6. Users - Bank guarantees are used by trading parties to avoid overseas associated risks while bonds are used by governments and corporations to raise huge amounts of money.
7. When It Occurs - Bank guarantees usually take place on demand by the borrower while bonds are conditional, ie. it consists of plenty of conditions.
8. Mode of Money Traveling - The main difference between a bank guarantee and a surety bond is that in a bank guarantee, the money is not directly transferred from a buyer to the seller. It is done through the bank that acts as a guarantee while in the case of a bond, the transaction is executed directly between the parties if there is no default on the side of the borrower.
9. Used For - A bank guarantee is generally liable to avoid any financial risks in the contracts while bonds are liable to avoid any performance risks imposed by the principal.
Now you know that both bank guarantees and bank bonds are the most important financial instruments providing payment assurance and protection to the parties involved in the trade transaction.