A:

A traditional bank loan involves a credit application and a conditional transfer of the bank's funds to the borrower. Bank guarantees, on the other hand, do not involve a direct cash transfer.

Instead, banks issue guarantees as a surety to a third party on behalf of one of the bank's customers. If the bank's customer fails to fulfill some contractual obligation with the third party, that party can call the bank guarantee and receive payment.

Traditional Bank Loan

One of the primary functions of banks is to accept money from those with excess present funds (savers) and rent out money to those with insufficient present funds (borrowers). A traditional bank loan involves a lump sum transfer of money to a borrower. The borrower promises to pay back the loan back with interest over a period of time.

Before a bank makes a loan, it investigates the likelihood that the borrower will pay back the money as stated in the note. Borrowers deemed too risky may be loaned smaller amounts, charged higher interest rates, forced to pledge collateral or denied the loan altogether. There are many different types of bank loans designed for a variety of different customers and purchases.

Bank Guarantee

Bank guarantees function as a form of insurance for a third party who has a contractual relationship with one of the bank's customers. This is best demonstrated with an example.

Suppose a private contractor is negotiating a job with a municipal government to construct a project. The government has never dealt with this particular contractor before and is leery of assuming the risk of working with a new entity.

The government might only accept the contractor's bid on the condition that the contractor receives a guarantee from his bank. The guarantee states that, in the event of default on the contract by the contractor, the bank will agree to pay a sum of money to the government. In this case, the government is the beneficiary of the guarantee.

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