A Bank Guarantee is a guarantee from a bank or other lending institution, confirming that the liabilities of the debtor will be met. Simply put the bank ensures that if the debtor doesn’t settle its liability, the bank will cover it. A Bank Guarantee allows a business to endorse its’ financial needs which otherwise they wouldn’t be able to, as when a certain liability is backed up by a promise of a bank to repay in case of the debtor’s default, the risk for the creditor substantially drops.
It is important to note the difference between a Bank Guarantee and a Letter of Credit. Both Bank Guarantee and a Letter of Credit secure a payment of a liability of the debtor. However, under a Bank Guarantee the money is paid only in the event of default of the debtor, whereas a Letter of Credit is a promise from the bank to repay the beneficiary a certain amount under an agreement concluded between the parties, once certain criteria are met, for example a service is completed. The banks usually request the amount secured by a Letter of Credit to be held on behalf of the debtor until the contractual obligations of the beneficiary are satisfied and the payment should be made.