Bank Guarantees (BG)
A Bank Guarantee (BG) is an irrevocable undertaking by a bank to pay a specified sum to a beneficiary if the bank's customer (the principal/applicant) fails to fulfil a contractual obligation. BGs are contingent liabilities — the bank only pays if a valid demand is made.
📌 Key Parties
| Party | Role |
|---|---|
| Applicant (Principal) | Customer who requests the BG; the party whose obligation is being guaranteed |
| Issuing Bank | Bank that issues the BG; bears the payment obligation on demand |
| Beneficiary | Party in whose favour the BG is issued; entitled to make a demand |
| Counter-Guaranteeing Bank | In cross-border deals, a local bank may issue against a counter-guarantee from the applicant's bank |
📄 BG Types
| Type | Description | Common Use |
|---|---|---|
| Performance Guarantee | Guarantees contractor will complete works per contract | Construction, government tenders |
| Bid Bond / Tender Guarantee | Guarantees tenderer will honour bid if awarded | Government and corporate tenders |
| Advance Payment Guarantee | Protects buyer if seller fails to deliver after advance payment received | Large procurement contracts |
| Financial Guarantee | Guarantees repayment of a financial obligation | Loan security, credit support |
| Retention Money Guarantee | Allows contractor to receive retention monies early | Construction defects period |
| Customs Guarantee | Guarantees payment of customs duties / taxes | Warehousing, re-export |
🛠️ BG Issuance Workflow
- Applicant submits BG application with underlying contract, BG wording required by beneficiary, and supporting KYC documents
- Credit assessment: BG amount charged against applicant's contingent liability facility
- Compliance review: beneficiary screening, country risk, purpose check (TBML)
- BG wording reviewed by bank's legal/trade team; standardised wording used or reviewed if bespoke
- BG issued — delivered to beneficiary directly (counter-signed hard copy) or via SWIFT MT760 (for bank-to-bank)
- BG recorded as contingent liability on bank's books; limit utilised
- At expiry, cancellation and limit release are processed according to the guarantee terms, governing rules and residual-risk procedures
- If demand received: bank validates demand is compliant; pays beneficiary; seeks reimbursement from applicant
🧮 BG Fee Calculations
Commission on Issuance
BG Commission = BG Amount x Commission Rate x (Validity Period in Days / 360)
Example:
BG amount: SGD 1,000,000
Commission: 1.0% per annum
Validity: 365 days
Commission = 1,000,000 x 0.01 x (365/360) = SGD 10,139
Contingent Liability Capital Charge (simplified)
Risk-weighted amount depends on the exposure measure, applicable credit conversion factor, counterparty risk weight and recognised credit-risk mitigation.
The regulatory-capital function must apply the prevailing rules to the specific guarantee; a universal 100% or 50% factor should not be assumed.
⚠️ Demand Under a BG
A BG demand is valid if:
- Made in writing before the BG expiry date
- Accompanied by required documents stated in the BG (e.g. statement of default)
- Signed by authorised signatories of the beneficiary
- Does not exceed the BG amount
On-Demand vs. Conditional BG
- On-Demand: The bank examines the demand against the guarantee terms without determining the underlying contractual dispute.
- Conditional: Bank requires proof of default before paying. Less common; slower resolution.
Injunction Risk: Applicant may seek court injunction to stop payment if they dispute the demand. Bank should seek legal advice immediately if injunction is threatened.
📋 Compliance & Controls
- BG facility approved as part of credit review; facility amount, tenor, and purpose approved
- Sanctions and AML screening on applicant and beneficiary before issuance
- Purpose verification: BG must support a legitimate underlying trade or contractual obligation
- Country risk: BGs issued in favour of beneficiaries in high-risk jurisdictions subject to enhanced due diligence
- BG wording reviewed to ensure demand conditions are clear and bank is not exposed to unlimited/open-ended liability
- All issued BGs tracked in trade finance system with expiry monitoring and automated alerts
- Expired guarantees are closed only when the bank's legal and operational release conditions are satisfied; return of an original may not by itself determine expiry
- Records retained under applicable legal, AML/CFT and institutional retention requirements