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How does a bank guarantee work?

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Quick Answer

According to Business Standard, a bank guarantee works by paying a previously specified amount of money to a beneficiary only in the event that a client defaults on a contract. When a bank client enters into a business contract that requires a third-party guarantee, the bank may agree to provide a certain amount to the beneficiary as a guarantee that the client meets the agreed contractual obligations.

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DBS, a leading financial services group, notes that to obtain a bank guarantee, the banking client must first enter into a contract with the beneficiary where both parties agree a guarantee is necessary. The client then approaches the bank to secure the guarantee. Once the bank is satisfied that the client meets its criteria, the guarantee is issued to the client, the beneficiary and the beneficiary's financial institution.

Business Standard reports that a bank guarantee may only cover a percentage of the total value of a contract. A bank guarantee allows a company to do business globally without its business partners attempting to discern how financially sound it is. When using a bank guarantee, the company is required to prove credit worthiness only to the issuing financial institution. A bank typically issues a bank guarantee only after completing an analysis of the financial status of the company to determine the amount of guarantee it provides.

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