GUARANTEES
During the course of business, banks are often required to furnish guarantees on behalf of their own customers in lieu of their
obligations, performance or other requirements. Section 126 of Indian Contract Act 1872, defines guarantees as a contract to
perform the promise or discharge the liability of a third person in case of his default.
Typesof guarantees
Financial Guarantees: These are direct credit substitutes wherein a bank, irrevocably undertakes to guarantee the repayment of 8 contractual
financialobligation. Financial guaranteesessentially can-ythesamecredit risk asadirectextensionof credit i.e., theriskof loss isdirectly linkedtothe
creditworthiness of the counterparty againstwhoma potential claimis acquired. Example : a)Guarantees for credit facilities; b)Guarantees in lieu
of repayment of financial securities; c) Guarantees in lieu ofmargin requirements of exchanges; d) Guarantees formobilisation advance, advance
money before the commencement of a project and formoney to be received in various stages of project implementation; e) Guarantees towards
revenuedues, taxes, duties, levies etc. in favour of Tax/ Customs / Port / ExciseAuthorities and for disputed liabilities for litigation pending at courts; f)
CreditEnhancements; g)Liquidityfacilitiesforsecuritisationtransactions; g)Acceptances(includingendorsementswiththecharacterofacceptance ; i)
Deferredpaymentguarantees.
PerformanceGuarantees: These are transaction-related contingencies that involve an irrevocableundertaking to pay a third party, in the event
the counterparty fails to fulfillor performa contractual non-financialobligation. Example : a. Bid bonds; b. Performancebonds and export
performance guarantees; c.Guarantees in lieu of security deposits / earnestmoney deposits (EMD) for participating in tenders;d. Retention
money guarantees; e.Warranties, indemnities
Deferred payment guarantee
This is a guarantee for a paymentwhich hasbeen deferred or postponed. In caseofpurchaseof capital goods likemachinery, thenecessity to
issuedeferred payment guarantee arises. In such guarantees, thebanks area undertaking to pay the instalmentsdue under thedeferred
payment schedule.Unlike allother LGshere thepaymentwill have to bemadeby thebanks on the accepted duedates and thereafter the
instalment is recovered fromthe party.
Advance payment under DPG: The terms of payment for the purpose of such guarantee, are normalt7 advance payment of 10-15% of the
price of the capital goods and payment of another 10-15% on receipt of the goods/documents. The balance amount, along with interest, is
payable ininstalments spreadover a period of 3-7years;which is secured by thedeferred payment guarantee.
Appraisal for DPG: The appraisal of a proposal involving issue of deferred payment guarantee has to be undertaken as it is done in case of a
termloan to see the long termviability of the operations, since the payment is tomadeout of the future cash generation fromthe activity.
PaymentMechanismunderDPG: As regards the paymentmechanism, normally the sellers drawusance bills of exchangewhich are accepted
by the buyer and counter-accepted by the buyer's bank (bank giving the guarantee). These bills are discounted by the sellerwith his bank and
on due date the seller's bank presents the bills for payment, which the issue bank pays to the debit of buyer's account.Where the buyer's
account does not permit such debit, bank has to pay the due amount and initiate steps to recover the payment from the buyer. Security :
Banks secure such guaranteesbyhaving chargeonthe assetspurchased andalso counter guaranteeof thebuyers.
During the course of business, banks are often required to furnish guarantees on behalf of their own customers in lieu of their
obligations, performance or other requirements. Section 126 of Indian Contract Act 1872, defines guarantees as a contract to
perform the promise or discharge the liability of a third person in case of his default.
Typesof guarantees
Financial Guarantees: These are direct credit substitutes wherein a bank, irrevocably undertakes to guarantee the repayment of 8 contractual
financialobligation. Financial guaranteesessentially can-ythesamecredit risk asadirectextensionof credit i.e., theriskof loss isdirectly linkedtothe
creditworthiness of the counterparty againstwhoma potential claimis acquired. Example : a)Guarantees for credit facilities; b)Guarantees in lieu
of repayment of financial securities; c) Guarantees in lieu ofmargin requirements of exchanges; d) Guarantees formobilisation advance, advance
money before the commencement of a project and formoney to be received in various stages of project implementation; e) Guarantees towards
revenuedues, taxes, duties, levies etc. in favour of Tax/ Customs / Port / ExciseAuthorities and for disputed liabilities for litigation pending at courts; f)
CreditEnhancements; g)Liquidityfacilitiesforsecuritisationtransactions; g)Acceptances(includingendorsementswiththecharacterofacceptance ; i)
Deferredpaymentguarantees.
PerformanceGuarantees: These are transaction-related contingencies that involve an irrevocableundertaking to pay a third party, in the event
the counterparty fails to fulfillor performa contractual non-financialobligation. Example : a. Bid bonds; b. Performancebonds and export
performance guarantees; c.Guarantees in lieu of security deposits / earnestmoney deposits (EMD) for participating in tenders;d. Retention
money guarantees; e.Warranties, indemnities
Deferred payment guarantee
This is a guarantee for a paymentwhich hasbeen deferred or postponed. In caseofpurchaseof capital goods likemachinery, thenecessity to
issuedeferred payment guarantee arises. In such guarantees, thebanks area undertaking to pay the instalmentsdue under thedeferred
payment schedule.Unlike allother LGshere thepaymentwill have to bemadeby thebanks on the accepted duedates and thereafter the
instalment is recovered fromthe party.
Advance payment under DPG: The terms of payment for the purpose of such guarantee, are normalt7 advance payment of 10-15% of the
price of the capital goods and payment of another 10-15% on receipt of the goods/documents. The balance amount, along with interest, is
payable ininstalments spreadover a period of 3-7years;which is secured by thedeferred payment guarantee.
Appraisal for DPG: The appraisal of a proposal involving issue of deferred payment guarantee has to be undertaken as it is done in case of a
termloan to see the long termviability of the operations, since the payment is tomadeout of the future cash generation fromthe activity.
PaymentMechanismunderDPG: As regards the paymentmechanism, normally the sellers drawusance bills of exchangewhich are accepted
by the buyer and counter-accepted by the buyer's bank (bank giving the guarantee). These bills are discounted by the sellerwith his bank and
on due date the seller's bank presents the bills for payment, which the issue bank pays to the debit of buyer's account.Where the buyer's
account does not permit such debit, bank has to pay the due amount and initiate steps to recover the payment from the buyer. Security :
Banks secure such guaranteesbyhaving chargeonthe assetspurchased andalso counter guaranteeof thebuyers.
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