What is a bank guarantee?
Individuals and businesses use bank guarantees to safeguard payments, manage risk, and protect their money. Learn more about the different types of guarantees and their uses here.
4 min read
Apart from basic banking services, banks and lending institutions meet a variety of needs for their consumers. One of their key banking offers are bank guarantees.Let’s dive in to learn more about it!
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What is a bank guarantee?
A bank guarantee is an agreement in which the bank acts as a guarantor for you, agreeing to cover your payment obligation to a third party. Here, the bank effectively agrees to act as a risk manager for you (applicant) and for the third party (beneficiary) in case you aren’t able to make the payment. In simple terms, if you can’t pay off your debt, a bank guarantee means that the bank will pay the bill.
Types of bank guarantees
There are different types of bank guarantees. Here are a few of the main ones:
Banks give these guarantees—also called bid bonds—in situations that involve a tender or contract. This type of guarantee is often used for large-scale projects, such as construction work or manufacturing. It’s effectively the bank paying damages if a company wins a tender, but then defaults on the contract and doesn’t begin work. A tender guarantee provides security that the company placing a bid for a contract is actually prepared to follow through and start the project.
Advance payment guarantees
Also known as a cash guarantee, this is where a bank commits to ensuring that any company doing labor gets paid. Whereas certain kinds of goods are paid for up front, many companies only invoice for their work after the services have already been delivered. With an advance payment guarantee, if a buyer doesn’t pay for any goods or services that the seller has already provided, then the bank is obligated to compensate the seller.
A performance guarantee ensures that a seller provides the buyer with the goods or services as specified in their contract. If this doesn’t happen and there’s a dispute, the bank pays damages to the buyer. This type of guarantee is also used for major building projects or manufacturing contracts. The key difference is that a performance guarantee makes sure that all the terms of a contract are fulfilled—not just that the project will start, but that it will get finished as agreed.
If a bank fails to meet its obligations, EU legislation protects money that has been deposited into accounts at that bank. Deposit guarantee schemes (DGS) are a type of government bank guarantee wherein the government refunds a partial amount to depositors whose bank has gone out of business. This is designed to do two things:
- Safeguard depositors' money by guaranteeing deposits up to€100,000
- Reduce huge withdrawals of money from banks
What is a digital bank guarantee?
In a digital bank guarantee, you’ll get automated bank guarantee services in the form of smart contracts. This process is designed to be quick, transparent, and more secure compared to analogue guarantees.
What is a bank guarantee letter?
A guarantee letter from the bank ensures they will pay a set amount to a beneficiary if the bank’s customer defaults on a certain payment or obligation.
Letters of credit vs. bank guarantees
You won’t generally won’t get a bank guarantee in US banks—they tend to offer letters of credit instead. But letters of credit are a bit different than bank guarantees. They’re essentially a legal document that banks use to guarantee a beneficiary that it will pay a set amount of money in case their client doesn't pay.
Compared to a bank guarantee, a bank takes on significantly more liability with a letter of credit. Why? Well, with a bank guarantee, the sum is only paid if the opposing party doesn’t live up to their contractual obligations. Furthermore, banks tend to be more involved in all transactions from start to finish when there’s a letter of credit, which can make the process more consistent but also more time-consuming.
How to apply for a bank guarantee
Both individuals and businesses can easily obtain bank guarantees, since most banks don’t impose strong restrictions. To get a guarantee from the bank, you must:
- Have a bank account in the bank to which you are applying for a guarantee
- Fill out the form specifying the amount and state the purpose of the guarantee
- Provide the timeframe for the guarantee
- Specify any terms and conditions for the payment
The bank may also require the following items from you:
- Solvency level
- Payment performance
- Availability of funds
- A security, agreement of assets like bonds, stocks etc., or liquid assets
How much is a bank guarantee?
When it comes to deposit guarantees, if you’re an eligible account holder at a given bank, your money is protected by the government up to a limit of €100,000. With the other types of guarantees, the amount depends on unique factors like the value of the contract or services that are being guaranteed.
What are bank guarantee charges?
These are fees that the bank charges for providing this service to you. They tend to be relatively affordable, costing 1.5% or less of the total amount of the guarantee.
How much does a bank guarantee cost?
Fortunately, the cost of a bank guarantee is usually affordable—you’ll need to pay around 0.5% to 1.5% of the guaranteed amount. If you make any changes to the document, you’ll also need to pay a re-documentation fee.
Manage your debts with N26
At N26, we aim to be transparent and fair about the fees we charge. When it comes to card payments, we never charge our customers fees on transactions made online or in-stores, anywhere in the world. We also don’t charge a markup on foreign currency payments and you’ll always get the benefit of Mastercard’s best currency exchange rate. Best of all, it’s free to open our standard N26 bank account, and there’s no account maintenance fee.
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