QA Series - S No 30 - Bank Guarantees

 

The Banking Tutor

Question Answer Series 2025

S No 30                                                                   29-07-2025

Bank Guarantee 

01. What is meant by NFB facility? 

A non-fund based facility is a type of financial service offered by banks or financial institutions that does not involve the immediate disbursement of funds. 

02. What are popular NFB products? 

Bank Guarantee, Letter of Credit, Deferred Payment Guarantee and Bills Co-acceptance Facility. 

03. What is a Bank Guarantee? 

A bank guarantee is a promise from a bank to cover a customer's financial obligations if the customer defaults. It's essentially a surety provided by the bank to ensure a beneficiary receives payment or fulfills a contract, even if the customer (applicant) cannot. 

04. Who are the parties to a Bank Guarantee? 

A bank guarantee involves three key parties: the Applicant, the Beneficiary, and the Bank (or Guarantor). The Applicant is the party who requests the bank to issue the guarantee, often as part of a contractual agreement. The Beneficiary is the party who receives the benefit of the guarantee, meaning they are protected against potential losses if the Applicant defaults on their obligations. The Bank is the financial institution that issues the guarantee and promises to pay the Beneficiary under certain conditions, such as the Applicant's failure to fulfill their contractual obligations. 

05. What is a Financial Guarantee ? 

A financial bank guarantee is a promise from a bank to cover a customer's financial obligations if that customer fails to meet them. It assures a beneficiary that a specific financial commitment, like loan repayment or payment for goods/services, will be fulfilled, even if the original customer defaults. Essentially, the bank acts as a guarantor, ensuring payment or performance on behalf of the customer. 

06. What is a Advanced Payment Guarantee?

An advance payment guarantee (APG), also known as an advance payment bond, is a financial instrument that assures a seller or contractor (beneficiary) that they will receive advance payment from a buyer or client (applicant) for goods or services, even if the buyer defaults on their obligations. Essentially, it's a type of insurance for the seller, guaranteeing the advance payment is protected. 

07. What is a Performance Guarantee? 

A performance guarantee is a contractual agreement where one party (the guarantor) promises to fulfill the obligations of another party (the principal) if the principal fails to do so. Essentially, it's a promise to perform or compensate if the primary party doesn't meet the agreed-upon terms of a contract. This is common in situations where one party needs assurance that the other will deliver a service, product, or complete a project as specified. 

08. What is Bid Bond Guarantee? 

A bid bond is a type of guarantee, often required in the tendering process, that assures a project owner that the winning bidder will enter into the contract and fulfill its obligations. It acts as a financial safeguard, ensuring the contractor is committed to the bid and possesses the financial capacity to undertake the project. If the winning bidder fails to proceed with the contract, the bid bond provides compensation to the project owner for losses incurred. 

09. What type of Guarantees Bank issue for purchase of Fixed Assts ? 

Deferred Payment Guarantee and Bills Co-acceptance. 

10. What are Conditional Guarantees ? 

The Guarantees which can be invoked by Beneficiary only after compliance with certain conditions are called Conditional Guarantees.

11. What are Unconditional Guarantees ? 

The Guarantees which can be invoked with in the period mentioned in the Guarantee, however without compliance of any other condition are called Unconditional Guarantees.

12. What is the other name of Unconditional Guarantees? 

Unconditional Guarantees are also known as Demand Guarantees. 

13. What is Claim Period in BG? 

The claim period is only a facility to the beneficiary enabling him to claim, within a specified period, the loss/damage caused to him during the validity period of the guarantee. 

14. What is Protective Clause in case of BG? 

A protective clause is one that determines and restricts the amount of guarantee and period of enforceability of the claim against Bank. 

15. What is a Onerous Clause in the context of BG ? 

Condition which is difficult to comply or without any certainty are called Onerous Clause. 

16. Can Bank issue BG without expiry ? 

While Bank Guarantees (BGs) typically include a validity period and an expiry date, there are specific situations where they may function without a definitive end date, often referred to as "evergreen" guarantees. Normally Banks do not issue BG without expiry Period. Only in extraordinary situations they may issue BG without expiry date. 

17. What are the precautions to be taken while issuing BG with Interest Clause? 

Interest should be ascertainable and quantified. Notional interest for the specified period should be calculated and specified in the guarantee itself to avoid ambiguity. For example, - interest @ ....% not exceeding a sum of Rs...........  While limiting the liability of the Bank in the protective clause, notional interest should also be taken into account and commission should be charged on the  amount including the interest component specified in protective clause. For all purposes guarantee amount and interest constitute guarantee liability. 

18. What are the precautions to be taken while issuing BG with Auto Renewal Clause? 

Automatic renewal clause is considered to be onerous. Normally, guarantees containing automatic renewal clause carry an additional risk of being required to be renewed at the request of the beneficiary with or without specific request from the borrower. Guarantees containing onerous clauses may be issued only after obtaining permission from the competent authority. 

19. What is the other name for Auto Renewal Clause?

Automatic Renewal Clause also known as SRC – Self Renewal Clause. 

20. What is Arbitration Clause in the context of BG?

An arbitration clause is a clause in a contract that requires the parties to resolve their disputes through an arbitration process. Although such a clause may or may not specify that arbitration occur within a specific jurisdiction, it always binds the parties to a type of resolution outside the courts, and is therefore considered a kind of forum selection clause. 

21. What is Jurisdiction Clause in the context of BG? 

The parties to a contract may mutually agree to refer the disputes to a particular Court or Courts. Such a clause in a contract is called as exclusive jurisdiction clause. The parties agree to exclusively refer the disputes arising from the contract, if any, to a particular Court or Courts.

22. What ids the other name for Arbitration Clause? 

Arbitration Clause is also known as the "Scott v. Avery clause." 

23. What is SFMS Clause in the context of BG ? 

In addition to sending Bank Guarantee in paper form, a separate advice of the Bank Guarantee shall be sent to the advising bank through SFMS by interfacing Flexcube Corporate through Middleware i.e, XMM package, after which the paper Bank Guarantee could become operative. 

24. When BG is issued by Bank what is the nature of liability of Bank ? 

It is Contingent in nature. 

25.  What is the maximum period for which BG can be issued by Banks in India? 

Maximum period for which BG can be issued is 10 years only. However, now Banks, selectively, can issue BG for more than 10 years also. 

26. What precautions to be taken by Bank while issuing BG for more than 10 years? 

While issuing Guarantees for more than 10 years, , banks are advised to take into account the impact of very long duration guarantees on their Asset Liability Management. 

27. What precautions to be taken while reversing entries related to BG without expiry period ? 

In case of guarantees issued without expiry period, liability cannot be reversed till the original guarantee bond is received. Guarantees without expiry period should be issued only under exceptional circumstances and not as a matter of routine. 

28. Which Committee had made recommendations related to BG ?

High Level Committee constituted in October 1991 (Chaired by Shri A. Ghosh, the then Dy. Governor of RBI made recommendations related to BGs. 

29. What are the guidelines related to reversal of entries of BG with Protective Clause ? 

If no claim or demand is received from the beneficiary on or before the validity period/ claim period of the guarantee on the due date, an intimation is to be sent to the beneficiary by a registered AD letter to the effect that the guarantee has expired and request them to return the original guarantee bond.  In the letter itself it must be made clear that the beneficiary is not entitled to invoke the guarantee as the guarantee has already expired. If in spite of this notice the expired guarantee bond is not returned by the beneficiary within one month from the date of notice, the liability under the guarantee may be reversed (without waiting for original guarantee). 

30. What is the impact if expired guarantees are not closed  by Banks ? 

All the expired guarantees to be reversed in the books of the bank against which no claim is pending with the bank as non-reversal of such liability has an adverse impact on the capital adequacy of the Bank. 

31. What are the guidelines related to reversal of entries of BG without  Protective Clause ? 

In the cases of BG which do not contain Standard Protective Clause, the guarantee can be reversed only after return of guarantee or a letter from the beneficiary stating that the beneficiary has no claim under the guarantee. 

32. What are the guidelines related to reversal of entries of BG issued in Judicial Proceedings ? 

The Bank Guarantees issued in Judicial Proceedings are to be kept valid, subsisting and alive till the disposal of the proceedings and till discharge by the Hon‘ble Court. 

33. What is the main recommendation of Ghosh Committee related to BG ?  

Guarantees of INR 50,000 and above should be jointly signed by two bank officials to mitigate the risk of malpractices. 

Next Issue  will be shared on 31^st  July 2025.

Sekhar Pariti

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