Introduction
Both bank guarantees and bonds are financial instruments that provide security to parties entering into contracts to exchange or sell goods or services. These instruments assure the buyer that the seller will not fail to fulfill their contractual obligations in the event of default.
Bank Guarantee vs Bonds
The main difference between Bank Guarantee and Bonds 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 included with a loan to ensure that the bank will pay the loss if the borrower defaults on repayments. A Bond acts as a security against the other party to an agreement and prevents them from breaking it.
Bank guarantees, also known as a letter credit, guarantee that payments between seller and buyer are made on time. Bonds, also known as surety bonds, protect both parties from the possibility of breaking contracts.
Difference between Bank Guarantee and Bonds in Tabular Form
| Parameter for Comparison | Bank Guarantee | Bonds |
| Definition of meaning | A bank guarantee is when a lending institution, such as a bank, acts as a guarantor to protect the borrower from financial loss. | A bond is a contract between the lender or borrower, which acts as a surety for payment for one of them. |
| Issuers | Bank guarantees can only be issued by certain banks as sureties for individuals. | Banks, governments and large companies can issue bonds to fund large amounts of money. |
| Payment method | Bank Guarantees require that the payment be made from the seller to the buyer via the bank. | Bonds are exempt from the obligation of the bank to pay bondholders. However, the bank can retain its fee if the payment is successful. |
| Accounting | Bank guarantees are always considered to be liabilities because they are a form of obligation for the bank to pay them out. | A bond is an insurance product. It can be accounted for as an asset as long as it goes smoothly. |
| Users | Individuals can use bank guarantees to secure international and cross-border transactions. This helps businesses grow. | Corporations and governments often use bonds to borrow large amounts of money. |
As a guarantee that the bank will pay the loan if the borrower defaults, a bank guarantee is often included in bank loans. A bond is a type of debt instrument that allows investors to lend money to corporations or government institutions in exchange for interest over the term of the bond. A bond is basically a loan that an entity issues and which can be invested by outside investors.
What is Bank Guarantee?
A bank guarantee is a promise made by banks or financial institutions to lenders that, if the borrower defaults on the loan amount, the bank will be a guarantor and cover all losses. Business entities often use bank guarantees to buy equipment, raw materials, and machinery. With a guarantee that the bank will be responsible for the amount even if the borrower cannot pay it back. Bank guarantees are often very expensive and have a longer validity. Banks may find them risky as they agree to pay any amount requested by the borrower by signing a bank Guarantee.
There are many types of Bank Guarantees.
-
Guarantees for deferred payments
These guarantees, which are typically given to exporters and last for a fixed time period, are often issued as a guarantee. The bank must pay the installments if the bank fails to cover the amount.
-
Financial Guarantee
These guarantees include the promise that the bank will reimburse the party in case of delay or complete failure to complete the project.
-
Advance Payment Guarantee
In the hope that the service provider will provide his services on schedule, advance payment is made. If he is unable to provide his services on time, the guarantees guarantee that the buyer will be refunded any money paid.
-
Performance Guarantee
These guarantees are typically based on the performance and quality of service. If the dealer fails to perform or is not up to standard, the bank will pay the amount.
-
Foreign Bank Guarantee
These guarantees are often similar to normal guarantees, except that they are offered for foreign beneficiaries or creditors.
A bank guarantee can be defined as a guarantee given by a lending institution that the bank will cover the total costs of a borrower in the event they default on their obligations or liabilities. A bank guarantee can be described as a provision in a bank loan that is placed before the lender agrees to lend the money. For providing the guarantee, the bank may also charge a fee. The bank will also charge a fee for providing the guarantee. This encourages consumers and companies to make purchases that they wouldn't otherwise make.
Bank guarantees are often provided by commercial banks to business owners or individuals who need to borrow money to purchase new equipment. The bank can guarantee that the debtor will be held responsible for any failure to fulfil their contractual obligations. Banks are willing to act as guarantors for business customers during a transaction. A majority of bank guarantees charge a small fee equal to a percentage of the contract amount. This is usually 0.5% to 1.5% of the total guaranteed amount.
There are many types of guarantees available, including performance guarantees, bid bond guarantees, performance guarantees as well as advance or delayed payment guarantees and financial guarantees. They can also be used for other reasons. These guarantees are often used in agreements between small firms and large organisations. A larger organisation might also want protection from counterparty risk. This requires that the smaller party receive the bank guarantee prior to their work.
What are Bonds?
A bank bond, or surety bond, is a type of contract between three people. The principal (the borrower), surety (the bank, any financial institution), and obligee (the lender). The surety acts as a guarantee to the obligee that the principal will comply with all terms of the bond. Bonds are a guarantee that the contract between the parties is executed according to their mutual agreement. They help protect consumers and governments from fraud, misinterpretation, or malpractices and allow businesses to thrive.
The bank or other organization acting as a surety backs a bond and pays for any losses. However, the principal must sign an indemnity agreement called a general agreement to indemnity. This agreement covers all businesses owned by the principal as well as its owners.
These are some of the types:
-
Contract Surety Bond
These bonds are usually owned by the project owner. The bond guarantees that the contractor will adhere to every contract specification and pay all expenses incurred by his workers.
-
Commercial Surety Bond
These bonds are often mandated by government agencies. They are used to protect public interest. The oblige here is the general public.
-
Fidelity Surety Bond
These bonds protect companies from frauds and malpractices committed by people who work in the cash or finance departments. These bonds are an effective form of protection for people's assets and money.
-
Court Surety Bond
Lawyers or attorneys usually require these bonds before they can proceed to court to make sure they receive their court fees and protect them from any losses.
Different governments and corporations use bonds to raise money or finance projects. The bond is also similar to an IOU. It is issued by a borrower and the lender. A bond issued by the entity is also at a specified coupon rate and par value. The investor lends the bond to the issuer for a specific time. In return, the investor receives coupon payments until the borrower has repaid the par value.
Bonds are issued when they reach maturity or expire. The maturity date refers to the date that the bond's principal amount is due to be paid to its owner. This includes details about the bond's terms and conditions and the amount of fixed or variable interest payments the borrower will have to pay. A portion of the total return bondholders receive for lending their money to an issuer is also made up by the interest payment or coupon rate. The total payment is determined by the coupon rate, which is the interest.
Bonds can be described as fixed-income securities. They are also one of the three main asset classes. Cash equivalents and stocks (equities) are the other main asset classes that investors are familiar with. While many government and corporate bonds can be traded publicly, others can only be traded privately or over the counter (OTC) between the borrower and lender.
A bid or tender bond
Bid Bonds are used to ensure that contractors have financial security and can take on any project if it is awarded. They are typically between 2% to 5% of the contract value and serve as a deterrent for any unsolicited tenders. It is possible for a contractor not to start but be awarded the project if there isn't a bid bond. The supplier of the tender would be left without a contractor. In the unlikely event that the contractor fails to pay a bid or tender bond, the supplier would be penalized with the amount of the bond.
Performance Bonds
Performance Bonds promise that the product will meet a specified standard. If they don't, a penalty will be imposed. These bonds are usually issued after a Tender Bond has been cancelled. These Bonds are financial guarantees. They do not guarantee that a bank will fulfill a customer's contract if the customer does not comply.
A bank or insurance company will usually issue a performance bond to ensure that a contractor completes a project on time.
If a task requires a payment or performance bond, then a bid bond will be required to bid for the job. As security for the job's completion, a payment or performance bond will be required when the work has been awarded to the winner.
Main Difference between Bank Guarantee and Bonds in Points
The main difference between Bank Guarantee and Bonds
- A Bank Guarantee is a method of transferring payment between the lender, borrower and bank. Bank or surety bonds are a type of insurance that prevents either party from violating a contract.
- Bank guarantees are typically to be paid when the borrower defaults on their payment. Bonds with maturity dates must be paid on the due date.
- Bank Guarantees can be obtained when the lender wants to borrow money, and the borrower cannot repay. Bonds, on the other hand, are conditional. There are many conditions attached to them.
- There is a major difference between Bank Guarantee and Bonds. In a Bank Guarantee, money is transferred from the buyer to the seller through the bank acting as a guarantee. While in Bonds, the transaction occurs directly between the parties if there is no failure by the borrower.
- The Bank Guarantee covers the financial risk of the contract project. A Bond covers the performance risk posed to the principal.
The Key Takeaways
- A bank guarantee is often included in a loan agreement. It promises that a bank will meet the borrower's obligations in case they default on the loan.
- Banks charge fees to guarantee your account.
- Entities can issue bonds to raise funds. An entity issues a bond to raise money. The buyer of the bond lends the bond amount for a period of time at a fixed interest rate.
- An entity issues bonds at a par value. Usually, the bonds are in $100 denominations.
Conclusion
Bank Guarantees and Bonds are instruments that provide protection and assurance to people who borrow and receive money. If a bank guarantees a payment, the bank will always be there. However, in the case of bonds, the bank is allowed to keep its fee if all goes well and the bank remains under no obligation. Although they have different functions, both instruments ensure that transactions and contracts are safe between parties.
References
- https://www.manchesterhive.com/view/9781847799913/9781847799913.00016.xml
- https://www.econstor.eu/handle/10419/168912
