Many people do not fully understand bank guarantees, nor the procedures for bank payment guarantees. Let’s explore bank guarantees and their procedures with the article below.
1 What is a Bank Guarantee?
According to Circular No. 07/2015/TT-NHNN, a bank guarantee can be understood as a commitment made by a third party (the guarantor) to the entitled party (the beneficiary) regarding the fulfillment of financial obligations on behalf of the guaranteed party.
For example: Company ABC undertakes Project Xmas. However, to ensure that Company ABC does not withdraw from the project, financial organization F will issue a bid guarantee letter to Company ABC, committing to the project timeline. If Company ABC fails to complete the project, Organization F will bear all the costs to the project’s bidding organization.
Bank guarantee is a form of business guarantee
Features of a Bank Guarantee:
- This is a dual, specific commercial transaction.
- Bank guarantees are unconditional (also known as independent guarantees).
- The guaranteeing organization acts not only as a guarantor but also as a banking business entity.
- This transaction establishes two interrelated yet legally independent contracts: the guarantee service contract and the guarantee/commitment guarantee contract.
- Bank guarantees are established and executed based on documents, from the commitment guarantee (guarantee letter) to the fulfillment of obligations by the guaranteed party, which must be established in writing.
2 What is a Bank Guarantee Letter?
A bank guarantee letter is a commitment between the guarantor and the guaranteed party
A bank guarantee letter is a commitment between the guarantor and the guaranteed party, established to ensure that the guarantor will fulfill the payment obligations on behalf of the guaranteed party if the latter fails to fulfill or properly fulfill their commitments to the beneficiary, a third-party entity (the customer).
3 Types of Bank Guarantees
Based on the Method of Issuance
- Direct Guarantee
- Indirect Guarantee
- Confirmed Guarantee
- Co-guarantee
Based on the Form of Utilization
Includes two forms: conditional and unconditional guarantees.
Based on the Purpose of Utilization
- Performance Guarantee
- Payment Guarantee
- Guarantee for Loan Repayment
- Bid Guarantee
- Guarantee for Advance Payment Refund
- Warranty Guarantee or Guarantee for Product Quality as per Contract
- Guarantee for Invoice Value Exemption
Other Types of Guarantees include:
- Standby Letter of Credit (L/C)
- Customs Guarantee
- Bill Guarantee
- Securities Issuance Guarantee
4 Bank Guarantee Procedures
Step 1 Sign the Contract
Both parties will sign a contract based on criteria such as payment, construction, bidding, and the partner party may request a bank guarantee to ensure the counterparty completes the project as per the signed contract.
Step 2 Prepare the Documents
According to Circular No. 07/2015/TT-NHNN, Article 13, the project recipient (customer) will prepare and send a guarantee request to the bank or financial institution, including:
- Request for Guarantee
- Customer Information
- Information on the Guaranteed Obligations
- Information on Security Measures (if any)
- Information on Other Related Parties (if any)
Bank guarantee procedures are carried out in 6 steps
Step 3 Review and Approve
Then, the guaranteeing organization will review the contents of the documents based on criteria such as the legality and feasibility of the guarantee project; the legal capacity of the customer; the form of security; and the assessment of the customer’s financial capacity. If all criteria are met, the organization will sign a guarantee issuance contract and a guarantee letter with the customer.
Step 4 Notify the Guarantee Letter
The guaranteeing organization will notify the guarantee letter to the customer’s partner, clearly stating the basic contents of the guarantee issuance contract.
Step 5 Fulfill the Guarantee Obligations
The guaranteeing organization will fulfill the guarantee obligations to the guaranteed party (the customer) if any issues arise, as per Article 21 of Circular No. 07/2015/TT-NHNN.
Step 6 Request for Financial Obligation Fulfillment
The guaranteeing organization will request the guaranteed party (the customer) to fulfill their financial obligations to the bank, such as repayment of principal, interest, and fees.
5 How is the Bank Guarantee Fee Accounted for?
Although financial institutions like banks will stand as guarantors for the guaranteed party, the guaranteed party must also pay a fee to the guarantor, compensating for the costs and risks that the financial institution may have to bear.
The guaranteed party must pay a fee to the guarantor to compensate for the advance financial costs
For the financial institution, the guarantee fee is considered a service fee and directly contributes to the bank’s profits.
In summary, this cost is similar to a “protection fee,” and there is no “free lunch” for businesses, units, or individuals. The cost of this financial institution’s “protection” for the business, unit, or individual in need of a guarantee is calculated using the following formula:
Guarantee Fee = Guaranteed Amount * Fee Rate * Guarantee Period
Where:
Guaranteed Amount: The amount that the guarantor pays on behalf of the guaranteed party when the latter is unable to make payments as per the contract.
Fee Rate (%): The guarantee rate applied by each financial institution or bank for different types of guarantees.
Guarantee Period: The duration of the guarantee commitment between the two parties.
Example of a bank guarantee:
– Guaranteed Amount: VND 100,000,000
– Fee Rate: 1% per year
– Guarantee Period: 3 years
=> Thus, the guarantee fee will be: 100,000,000 * 1% * 3 years = VND 3,000,000
The above explanation provides a better understanding of this financial arrangement.
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