Bank Guarantee Explained

Collateral Transfer encompasses the term of ‘lease’ or ‘leasing’ as a descriptive term. Whilst it is not possible to physically lease a Bank Guarantee (BG) or Standby Letter of Credit (SBLC), see WHY LEASING it is possible to effectively import these bank instruments (BG’s and SBLCs) on a ‘rental’ basis.

A Bank Guarantee is a method to secure or guarantee a payment. They are commonly used a Credit Facility Guarantees to secure or underpin credit lines, loans and other forms of credit advancement. Equally, SBLC’s (or Standby Letters of Credit) are used for the same purpose, although a Bank Guarantee is better suited for the job.

Bank Guarantees can be effectively ‘rented’ from a third party known as a ‘Provider’. Providers are often large private equity companies, hedge funds and wealthy family offices. They enter into Collateral Transfer Agreements with entities that wish to ‘borrow’ or ‘rent’ security in the form of a BG or SBLC. The Provider will pledge his assets (cash, gold, liquid stocks and shares, etc.) with his bank and instruct the issue of a BG or SBLC to the recipient in return for a Contract Fee (or ‘rental’ payment) generally on an annual basis. The recipient will indemnify the Provider against loss and will therefore agree to extinguish any loans or credit secured on the Guarantee prior to its expiry. As there is a ‘promise’ to remove any encumbrances or effectively to ‘return the Guarantee at expiry’ it resembles the act of leasing, hence the term ‘leasing of Bank Guarantees’.

The Parties to these transactions are the Provider and the Recipient. Their respective banks and bankers are not party to the Collateral Transfer Agreement as they will simply “accept instructions” from both parties. The Issuing Bank will act for the Provider and take his instructions; the Recipient Bank will act for the Recipient and further take his instructions. Banks do not directly enter into these facilities as the assets underpinning the whole transaction belong to a third party outside the bank (i.e. the Provider). The Recipient Bank may offer to extend credit to the Recipient against the security of the incoming Guarantee. However, the Recipient Bank will have no other role than to receive the Guarantee and accept it as security for any credit granted to the Recipient or Beneficiary of it.

There are several new private banks being formed specifically for collateral management and we may see in the next few years, private banks offering these services by utilise their own balance sheets to make such commitments. However currently, they are done off the bank balance sheet. This means that the Guarantee being issued is not issued on the strength of the bank or the banks rating. All Guarantees issued under this manner are for ‘value received’ and therefore the bank rating is not so important.

A Recipient Bank may judge the strength of the incoming Guarantee by the Issuing Banks performance on honouring its payments as depicted by their own experiences with that certain bank. As Bank Guarantees cannot be bought or sold or traded in any way, bank ratings are not affirmed to the instrument.

Recipients of Bank Guarantee or indeed SBLC’s have a specific purpose and requirement. The Guarantee is therefore worded for such purpose, i.e. to secure a credit or loan or to secure (third party) performance or contractual obligations.