CRIDIT MANAGMENT

MBA Banking & Finance

3rd Term
Letter of Guarantee…issuing
bank’s risks and obligations
Definition of Guarantee
A guarantee is an undertaking given by a person/bank to
be answerable for the debt, default or miscarriage of
another person/bank.
It is also defined as a contract to perform the promise
or discharge the liability of a third person in a case of his
default.
A guarantee may be specific or continuing. When the
guarantee is specific, the guarantor is answerable for a
particular loan only. In case the guarantee is continuing,
the guarantor shall promise to pay whole or part of
transactions carried out by the debtor.
Parties Involved in Guarantee
There are three parties in guarantee:
1. Principal Creditor
2. Principal Debtor.
3. Guarantor
 The primary liability to pay the debts falls on the
original debtor. The guarantor will pay only the
principal debtor fails to pay whole or part of agreed
debt.
 The guarantor is answerable for the loan if the debtor
defaults. Guarantor has no interest in the contract
between principal Creditor and principal debtor.
 Capacity to contract

The person or firms who are able to make contracts may

stand as surety for loans.
 Minors and persons of unsound mind are not eligible to
enter into contract of guarantee.
 married women have capacity to contract only against
their separate estates. The bank however should avoid
accepting guarantee of married women.
Types of Bank Guarantee
1. Shipping Guarantee: addressed to shipping companies
requiring the issue of delivery orders in the absence of
original bill of lading.
2. Financial Guarantee. These are guarantees given by the
bank to financial institutions (e.g. IDBP) and companies
( the creditors or beneficiary) undertaking to pay the debts
of its customer(the principal debtors) in the event of the
default by the customer.
3. Tender Guarantee / Bid Bonds: These are issued by the
bank to avoid the deposit of the earnest money by its
customers when they tender for contract. The amount is
usually 1% to 20% of the contract value and the duration is
for very short period until the bids are opened and the
contract awarded. Once the bank issue the bid bond, it is
usually committed to supporting the project by issuing
further guarantees such as performance bonds etc.
4. Performance Guarantee/Performance Bond:
These are issued by a bank on behalf of its customer
who has entered into a contract to supply goods or
perform other services and the guarantee compensation
in term of money in the event of non performance of
such contract.
It is usually for 5% to 10% of the value of the contract
and would remain in force throughout the period of the
contract at a constant amount.
5. Advance Payment Guarantee (APGs)
These are issued where a customer receives an advance
payment in respect of the work to be performed or
goods to be supplied under a contract undertaken by
him and the bank as a guarantor, undertakes to repay
the amount or the goods not supplied according to
contract. Interest free cash payment is usually made to
the client by the principal to support the start up
operation of the contract against the issue of the bank
guarantee.
6. Equipment bond:

These are issued where the customer receives and uses

equipment made available to him by the employer. The
customer progressively requires a theoretical ownership interest
through the presentation of progress certificate which include
the depreciation allowance. This represents advance payment in
kind by the employer who is assured that equipment will be
effectively used on the work site.
7. Transportation Bond:
These bonds are issued where the customer has undertaken to
transport capital equipment (imported by the employer for the
project) from the harbor to the worksite.
8. Retention Money bond (RMBs)
These are issued to avoid retention of money (usually)ten
percent )by the employer from each progress payment due to
the customer Construct but also to operate more importantly, to
operate successfully during a previously agreed period of time.
In order to cover hither to untraceable mistakes or faults in
the completed construction work, until usually one
following final completion o\f the project.
9. Working Capital Replenishment Bond: (WCRG)
These are issued by the bank in favor the employer who
advance funds to the contractor to bridge financial
payment delays on receivable due by himself.
10. Maintenance Bond: These are issued at the end of
construction period remain outstanding un till the end of
maintenance period. This is usually one year. The
purpose of this bond is to prevent the contractor from
leaving the construction site after the construction is
completed and the last progress payment received.
11. Completion Bond: in many cases construction
companies and turn-key contractors are committed not
only to
12. Custom Bond:
These are often requested to be issued in connection
with imported equipment which are subsequently re-
exported upon completion of the project. By giving such
a bond, exemption is obtained from paying import duties
and sale tax to the custom authorities of the country
involved.
13. Deferred Payment Guarantee:
Issued on behalf of an importer customer to cover
deferred payment terms agreed upon between him and
the supplier of plant and machinery.
Risk for the Bank
1. The bank under takes great risk by advancing loans on
sureties. The guarantor may lose his property during the
period of loan contract. If the debtor fails to pay the
debt, the bank can not recover the amount from the two
parties.
2. In case the debtor fails to repay the loan, the bank may
not be able to get back the money even by suing the
debtor and the guarantor. The case may fail on technical
grounds.
3. If at any time the bank has to change the constitution
or it has to amalgamate with other banks, the
guarantee is terminated unless otherwise stated.
Precautions:
Greater need for analysis of financial standing and for
ascertaining the performance ability of the customer.
Mark up
Mark up at the rate of 4% per annum out of which 2.50%
is paid to SBP by the commercial bank. Mark up is charged
at the time of realization/adjustment of the finance and for
finance on half yearly basis.

Post-shipment Finance for Export

Meaning: Post shipment finance is provided to meet working
capital requirements after the actual shipment of goods. It
bridges the financial gap between the date of shipment and
actual receipt of payment from overseas buyer thereof.
Whereas the finance provided after shipment of goods is
called post-shipment finance.
When the exporter send their export bill on collection basis,
they may avail post shipment finance under Part-I of
export refinance scheme. It is allowed on case to case
basis, subject to sanctioned limit fro head
office/controlling office, and its strict terms.
 Following documents are submitted by exporters for post
shipment refinance, apart from other documents
/formalities to be observed in term of sanction advice.
1. Demand promissory note for the finance value.
2. Undertaking IB 10
3. Letter of buy back cum indemnity (IB 9).
4. Letter of discounting of export bill (IB 20).
5. Demand promissory note for mark up value
6. Three copies of invoices
7. Three copies of transport documents B/L (Bill of landing)
or AWB (airway Bills).
8. Three copies of firm contract or L/C
9. Three copies of form “E”
10. Declaration regarding previous finance (if any).
11. Mark up agreement (IB 6).
12. Short shipment notice (if any).
13. Form EC
Security:
The exporter bill against which finance provided is the
primary security. A collateral security is obtained as per
term of sanction advice.
Repayment Procedure
Finance is repaid to SBP through coordinating office on
realization of proceeds or at due Date after 180 days
which ever occur first, failing which penalty is charged
by the SBP
Penalty: No penalty is charged in case of post shipment
finance. However, exporters are liable to repatriate the
proceeds of sale proceeds of exports in accordance
with exchange control regulations etc.