Feb 22, 2023
The price of a bank guarantee
Like all financial products, there are costs associated with utilising bank guarantees, but when used effectively, they form an important part of a finance team’s armoury.
What is a bank guarantee?
A bank guarantee is a physical document issued by the bank on behalf of their customer, providing an unconditional and irrevocable undertaking to pay the holder the amount of the guarantee upon presentation.
This allows organisations to make commitments without the need to hand over cash and impact their working capital.
These documents are typically used as security for property or goods, for contracts to support things like construction works, or even used as a bond for performance milestones.
Bank guarantees had been paper-based for around 200 years until the launch of the Lygon Arc platform, which was the first in the world to digitise the end-to-end bank guarantee process.
Understanding the costs of using bank guarantees
The cost of using a bank guarantee can vary and is typically influenced by a few different factors.
These factors include the type of the guarantee, the amount of the guarantee, the creditworthiness of the applicant requesting the guarantee, the project the guarantee is supporting, and the amount the financial institution charges for providing this service (for example, annual fees or renewal fees).
Based on the above, the cost of a bank guarantee will typically then be calculated as a percentage of the guaranteed amount in use.
An applicant can obtain a bank guarantee from a range of financial institutions, regardless of whether they have an ongoing relationship with the bank.
With many financial institutions offering bank guarantees, there is significant competition in the market.
Financial institutions can sometimes offer benefits such as preferential rates or exclusive access to digital bank guarantees through Lygon to differentiate from their competitors.
Balancing the benefits and costs associated with bank guarantees
Bank guarantees can be an essential part of a finance team's credit management strategy, giving organisations the ability to preserve their cash flow and secure things like projects or property with beneficial terms.
Whilst there are costs associated with obtaining and managing the issuance of bank guarantees, it should be relatively straightforward to calculate whether a bank guarantee is a good fit for a specific business purpose.
Each financial institution will be able to provide clear costings for a bank guarantee facility, so organisations can calculate whether the business opportunity or risk mitigation benefits outweigh the financial costs and operational costs of utilising bank guarantees.
How to get the best from a bank guarantee
Bank guarantees are best utilised by finance teams as one of several risk management tools and financial products that support the organisation's objectives.
It’s essential for organisations to understand the costs and terms of the bank guarantee so they can be used strategically with the most impact.
If the business is organised and has a good understanding of how the instrument works and the costs associated with them, it should be able to extract the benefits of using a bank guarantee with ease.
Effective management of a bank guarantee and data cleanliness throughout the process is critical to extracting the maximum impact from a bank guarantee.
This prevented organisations from getting the best from their guarantees for many years.
But with the introduction of our digital bank guarantee platform, data management is now a lot more straightforward.
With a user-friendly dashboard and in-depth reporting, organisations can now manage their data easier, allowing them to stay on top of the costs and the terms and conditions of their different bank guarantees on the platform.
For most organisations, taking a considered approach to managing risk and protecting cash flow means that often, the benefit of using bank guarantees far outweigh the costs associated with using these instruments.
Bank guarantees are a valuable tool for organisations looking to manage their risk and preserve cash flow across various business activities.
To reduce the potential costs of using a bank guarantee, it’s important to shop around between financial institutions to ensure your organisation has the best rates and terms.
It is equally important to carefully review and negotiate the terms of the guarantee with the issuing bank in the first instance.
Effective management of a bank guarantee once in use makes it easier to manage the costs associated with the instrument.
Whilst paper bank guarantees are still in use, the introduction of digital bank guarantees through Lygon has made this a much simpler process than before.
To learn more about the platform for digital bank guarantees and which banks are giving applicants the chance to utilise them, get in touch.
From the blog
Paper vs digital: The hidden costs of the paper bank guarantee lifecycle
Lygon Explained #2: Applicants, beneficiaries and issuers