How Bank Guarantees Work
Bank guarantees are credit commitments made with customers in order to make international exchanges easier and successful for both importers and exporters.
We could define bank guarantees as the commitment given by the financial institution (guarantor) to pay a certain amount to the beneficiary (usually the exporter) if it presents documents previously agreed upon and which confirm that the other party has not complied with its obligations (the payment of the importer normally). Through a bank guarantee, the exporter is assured of recovering the goods delivered even if the buyer does not pay.
The bank guarantee establishes the amount and date that the seller is to receive payment if the importer does not fulfill its obligations.
In order for bank guarantees to be valid, they need to specify the period for which the bank can pay for the merchandise. Bank guarantees do not have indefinite duration. If the guarantee is not used, it means that the transaction was satisfactory for the importer and exporter and the bank does not need to mediate.
There are three basic kinds of bank guarantees:
There is a period before the bank guarantees comes to being. Banks can decide to grant the credit and reserves the funds and in the meantime, it assesses the proposal.
Technical: they are necessary for companies or organizations with a commitment to public service or some international body.
The most common reason that motivates the use of bank guarantees are financial. The financial institutions provide the payment for the transactions when one part fails to do so.
Bank guarantees are beneficial to the importer because they protect them when the exporter does not fulfill its obligations. In the case that the merchandise brought by the exporter was of a lower quality that the one agreed before hand, or if it was damaged upon arrival the bank guarantee will refuse to pay the exporter for such goods.
On the other hand, when bank guarantees are given to an exporter it means that the exporter is protected against noncompliance of the importer. These types of bank guarantees make sure that the importer makes the payments for the merchandise it has received on a timely basis, otherwise the bank would cover those responsibilities.
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