Bank Guarantee: Meaning, Types, Process, Charges, Accounting & Examples

Fintaxman September 04, 2025

Bank Guarantee: A Complete Guide

A bank guarantee (BG) is a financial instrument in which a bank provides assurance to a beneficiary that it will fulfill the obligations of a borrower in case the borrower defaults. It acts as a promise by the bank to cover losses up to a specified amount if the customer fails to meet contractual obligations. Bank guarantees are widely used in business transactions to reduce risk and build trust between parties.


    What is a Bank Guarantee?

    A bank guarantee is a commitment by the buyer’s bank to ensure payment or fulfilment of contractual obligations. If the buyer fails to make a payment or meet contractual terms, the bank intervenes and pays the beneficiary. In essence, the bank provides security to the beneficiary while supporting the borrower’s business needs.

    Key Points:

    • It assures the beneficiary that the bank will honor the contract if the applicant cannot.
    • It serves as a non-fund-based credit facility.
    • It facilitates transactions that would otherwise be too risky for the beneficiary.

    Parties Involved in a Bank Guarantee:

    1. Applicant/Borrower: Requests the guarantee from the bank.
    2. Beneficiary: Receives the guarantee and benefits from bank assurance.
    3. Issuing Bank: Provides the guarantee and assumes the risk if the borrower defaults.
    4. Beneficiary’s Bank: Sometimes involved to receive and confirm the guarantee.

    How Does a Bank Guarantee Work?

    Bank guarantees reduce trust and credit issues in business transactions. If the borrower fulfills the contract, the bank’s obligation becomes null and void.

    Example:

    A buyer wants to purchase computer equipment worth INR 1 crore. The buyer requests a bank guarantee from their bank. The bank charges a fee and issues the guarantee to the seller. Once the buyer pays the amount, the guarantee is nullified.

    Bank guarantees are usually issued against a strong financial history. Banks evaluate the applicant’s past banking behavior, creditworthiness, liquidity, and credit ratings (e.g., CRISIL and CIBIL).

    Who Can Issue a Bank Guarantee?

    All major banks, non-banking financial companies (NBFCs), and lending institutions are authorized to issue bank guarantees.

    Functions of a Bank Guarantee

    1. Provide Immediate Credit: Enables entrepreneurs to start projects without upfront capital.
    2. Bridge Trust Gap: Ensures sellers trust buyers when payments are delayed.

    Uses of Bank Guarantee

    • Large companies often require guarantees from small vendors.
    • Used in credit-based purchases to assure payment.
    • Certifies the credibility of individuals and businesses.

    Features of a Bank Guarantee

    • Builds confidence between lenders and borrowers.
    • Valid for a specific period and renewable upon maturity.
    • Can be secured or unsecured, depending on terms.

    Importance of a Bank Guarantee

    • Guarantees payment to the beneficiary.
    • Ensures smaller vendors can engage with larger companies.
    • Increases credibility and trust in business dealings.

    Bank Guarantee Eligibility and Process

    • Any individual or business with a good financial record is eligible.
    • The bank evaluates previous banking history, creditworthiness, and collateral if required.
    • Approvals are given once all criteria are satisfied.

    Documents Required:

    • Application form
    • Bank guarantee letter
    • Stamp paper (as per State Stamp Act)
    • Board resolution (for private/public limited companies)

    Bank Guarantee Charges

    • Charges vary according to risk type (financial BG usually costs more than performance BG).
    • Fees are typically 0.50–0.75% of the BG value per quarter.
    • Additional charges may include application processing, documentation, and handling fees.

    Rules and Regulations for Bank Guarantees in India

    • Officers signing BGs must provide full details for verification.
    • Initial BG period: 6 months, extendable if agreed.
    • BGs should generally not exceed 10 years.
    • Banks approve financial guarantees more readily than performance guarantees.

    Types of Bank Guarantee

    1. Deferred Payment Guarantee: Payment in installments for capital goods or machinery.
    2. Financial Guarantee: Bank pays if a project is delayed or incomplete.
    3. Advance Payment Guarantee: Refund provided if the seller fails to deliver.
    4. Foreign Bank Guarantee: Issued for foreign beneficiaries.
    5. Performance Guarantee: Covers compensation for inadequate or delayed performance.
    6. Bid Bond Guarantee: Ensures project contractors fulfill bid obligations.

    Advantages of Bank Guarantees

    For Applicants:
    • Enables business growth and entrepreneurial activity.
    • Low fees compared to risk coverage.

    For Beneficiaries:
    • Reduces risk and increases confidence in transactions.
    • Ensures due diligence has been performed.

    Disadvantages of Bank Guarantees

    • Often requires collateral, which can be restrictive for new or small businesses.
    • Start-ups or companies with limited financial history may face difficulties.
    • Banks may not approve guarantees for loss-making organizations.

    Bank Guarantee vs Letter of Credit (LOC)

    Particulars

    LOC

    BG

    Nature

    Bank commits to pay if services are performed

    Bank guarantees payment if applicant defaults

    Primary liability

    Bank

    Bank only pays on default

    Payment

    As per service delivery

    Only upon default

    Parties

    Multiple (Issuing Bank, Beneficiary, Advising Bank)

    Three parties (Bank, Applicant, Beneficiary)

    Suitability

    Mainly import/export

    Any business or personal transaction

    Risk

    Bank assumes higher risk

    Customer assumes primary risk

    Other Comparisons:
    • Performance Bond: Covers losses from faulty services/products.
    • Corporate Guarantee: Corporate entity liable for debts.
    • Standby Letter of Credit (SBLC): Covers broader financial and non-financial risks.

    Accounting for Bank Guarantees (BGs) 

    We’ll consider four types of BGs: Performance, Financial, Advance Payment, and Deferred Payment.

    1. Performance Bank Guarantee

    Scenario:
    • Company pays BG fee ₹10,000 to the bank.
    • BG invoked due to non-performance: Bank pays ₹1,00,000 to the beneficiary.
    Journal Entries:
    • Fee paid:
    Bank Guarantee Charges A/C       Dr 10,000
           To Bank A/C               10,000

    • BG invoked (loss):
    Loss on Bank Guarantee A/C       Dr 1,00,000
           To Bank A/C               1,00,000

    T-account

    1. Bank Guarantee Charges A/c

    Dr (₹)

    Cr (₹)

    Fee Paid 10,000

    2. Loss on Bank Guarantee A/c

    Dr (₹)

    Cr (₹)

    BG Invoked 1,00,000

    3. Bank A/c

    Dr (₹)

    Cr (₹)

    Payment (Fee + BG) 1,10,000

    Narration/Explanation:
    1. The Bank Guarantee Charges account is debited (expense incurred) when the fee of ₹10,000 is paid.
    2. When the BG is invoked, it results in a loss of ₹1,00,000, so "Loss on Bank Guarantee" is debited.
    3. The total outflow of ₹1,10,000 (₹10,000 fee + ₹1,00,000 invoked guarantee) is credited to the Bank Account, reducing cash/bank balance.

    2. Financial Bank Guarantee

    Scenario:
    • Fee paid ₹5,000.
    • Company defaults on loan; bank pays creditor ₹5,00,000.
    Journal Entries:
    • Fee paid:
    Bank Guarantee Charges A/C       Dr 5,000
           To Bank A/C               5,000

    • BG invoked:
    Loan Liability A/C               Dr 5,00,000
           To Bank A/C               5,00,000


    T-account

    1. Loan Liability A/c

    Dr (₹)

    Cr (₹)

    BG Invoked 5,00,000

    2. Bank Guarantee Charges A/c

    Dr (₹)

    Cr (₹)

    Fee Paid 5,000

    3. Bank A/c

    Dr (₹)

    Cr (₹)

    Payment (Fee + BG) 5,05,000

     Explanation / Flow:
    • When the Bank Guarantee is invoked, the bank pays the beneficiary. That amount (₹5,00,000) becomes a Loan Liability (since bank pays on behalf of the borrower). → Credit to Loan Liability A/c.
    • The fee (₹5,000) is an expense, so it’s debited to Bank Guarantee Charges A/c.
    • The Bank account shows a total outflow of ₹5,05,000 towards (i) Guarantee invoked + (ii) Fee.

    3. Advance Payment Guarantee

    Scenario:
    • Buyer pays advance; BG fee ₹2,000.
    • Supplier fails; bank reimburses ₹2,00,000 to buyer.

    Journal Entries:
    • Fee paid:
    Bank Guarantee Charges A/C       Dr 2,000
           To Bank A/C               2,000
    • BG invoked (recovery from bank):
    Bank Receivable A/C              Dr 2,00,000
           To Bank A/C               2,00,000

    T-account

    1. Bank Receivable A/c

    Dr (₹)

    Cr (₹)

    Recovery from Bank 2,00,000

    2. Bank Guarantee Charges A/c

    Dr (₹)

    Cr (₹)

    Fee Paid 2,000

    3. Bank A/c

    Dr (₹)

    Cr (₹)

    Payment (Fee + BG) 2,02,000

     Explanation / Flow:
    • "Bank Receivable" represents the amount expected from a counterparty / beneficiary reimbursement (₹2,00,000). So, that account is debited.
    • Bank Guarantee Charges (₹2,000) are treated as an expense account, therefore debited as well.
    • Total payment from Bank’s side is ₹2,02,000 (200,000 recovery + 2,000 charges). That reduces Bank balance, hence credited in Bank A/c.

    4. Deferred Payment Guarantee

    Scenario:
    • Buyer purchases machinery on credit.
    • BG fee ₹3,000 paid; BG invoked in installments: ₹50,000 + ₹50,000.
    Journal Entries:
    • Fee paid:
    Bank Guarantee Charges A/C       Dr 3,000
           To Bank A/C               3,000 
    • BG invoked in two installments:
    Machinery Payable A/C            Dr 50,000
           To Bank A/C               50,000

    Machinery Payable A/C            Dr 50,000
           To Bank A/C               50,000

    T-account

    1. Machinery Payable A/c

    Dr (₹)

    Cr (₹)

    BG Installment 1 – 50,000

    BG Installment 2 – 50,000

    Total Dr = 1,00,000

    2. Bank Guarantee Charges A/c

    Dr (₹)

    Cr (₹)

    Fee Paid 3,000

    3. Bank A/c

    Dr (₹)

    Cr (₹)

    Payment (Fee + Installments) 1,03,000


    5. Security/Collateral for BG (Applicable to all types)

    Scenario: Bank requires 100% FD as security for BG.

    Journal Entry:
    Bank Guarantee Margin A/C       Dr 1,00,000
           To Bank A/C              1,00,000

     On BG expiry:

    Bank A/C                        Dr 1,00,000
           To Bank Guarantee Margin A/C 1,00,000

     


    Key Notes
    1. Bank Guarantee Charges: Always recorded as expense.
    2. BG Invoked: Recorded as loss, liability, or receivable depending on type.
    3. BG Expiry without invocation: Only fee recorded; no additional entries.
    4. Collateral/FD Margin: Recorded as asset; released after BG expiry.

    FAQ's

    When is a bank guarantee required?

    When funds are insufficient or trust is lacking between parties.

    Is a bank guarantee refundable?

    Yes, it becomes null and void once dues are paid.

    Who is the beneficiary?

    Typically, the seller or creditor.

    Difference between expiry date and claim date?

    Claim date = when beneficiary claims payment; Expiry date = last date to claim.

    Can a bank guarantee be amended, extended, or revoked?

    Yes, amendments and extensions are possible through formal applications. BG is revoked automatically upon completion or payment.

    Is it possible to apply for a bank guarantee online?

    Yes.

    What security is required?

    Usually collateral or 100% of a fixed deposit. Banks may also consider past performance.


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