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A guarantee from a lending institution ensuring that the liabilities of
a debtor will be met. In other words, if the debtor fails to settle a debt,
the bank will cover it. A bank guarantee enables the importer or buyer (debtor)
to acquire goods, buy equipment, or draw down loans, and thereby expand
business activity.
On the other hand, an importer not only can use bank guarantees to secure
payments for the goods to be imported from China, they may also ask the
supplier or exporter in China to obtain bank guarantees to assure the performance
of a given sales/purchase or in an other word, import/export contract, e.g.,
carrying out production and delivery in a timely manner and in conformance
with the specifications and quality standards set forth in the contract.
In the global trade process, the banks of the both sides can always play
critical leverage roles that may eventually help both importers and exporters
to reach final agreements on the typically "hard to settle" cross border
global trade terms. There are two variations of bank guarantees in export
extort related global trades, i.e., leased bank guarantees and demand bank
guarantees. These bank guarantees are common used in the process of import
from China.
Leased Bank Guarantee
A bank guarantee that is leased to a third party for a specific fee. The
issuing bank will conduct due diligence on the creditworthiness of the customer
looking to secure a bank guarantee, then lease a guarantee to that customer
for a set amount of money and over a set period of time, typically less
than two years. The issuing bank will send the guarantee to the borrower's
main bank, and the issuing bank then becomes a backer for debts incurred
by the borrower, up to the guaranteed amount.
Leased bank guarantees tend to be very expensive; fees can run as high as
15% of the guarantee amount every year. The fee is usually made up of an
initial setup fee and an annual fee, both of which will be a percentage
of the dollar amount to be "guaranteed", or covered by the issuing bank
in the event that the company can't promptly pay its debts.
This option for financial backing is typically only used by smaller enterprises
that are desperate to expand operations or fund a specific project; they
will have typically exhausted other opportunities to raise financing or
obtain a letter of credit from their own bank. Many top worldwide banks
will lease bank guarantees, usually with a minimum amount of $5 million
to $10 million, all the way up to $10 billion and more.
Demand Bank Guarantee
A type of protection that one party in a transaction can impose on another
party in the event that the second party does not perform according to predefined
specifications in the contract or agreement. In the event that the second
party does not perform as promised, the first party will receive a predefined
amount of compensation by the guarantor, which the second party will be
required to repay.
For example, an importer of industrial equipments in the U.S. can ask a
Chinese manufacturer or exporter for a demand bank guarantee. The exporter
goes to a bank with which they have business relations to purchase
a guarantee and sends it to the American importer. If, for example, the
exporter or manufacturer does not fulfill its end of the agreement, the
American importer can go to the bank and present the demand guarantee. The
bank will then give the importer the predefined amount of money specified,
which the exporter will be required to repay to the bank.
The demand guarantee is very similar to the "letter of credit" except that
the demand guarantee provides much more protection. For instance, the letter
of credit only provides protection against non-payment, whereas a demand
guarantee can provide protection against non-performance, late performance
and even defective performance.
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