When it comes to managing the risk and safety of long-term projects, a bank guarantee promises that if the company carrying out the project defaults on any of its loans, the bank will cover the costs or losses. This guarantee increases the confidence of the vendors who need to give large amounts of their products or services, usually on credit, to complete their part of the project.
The Importance of Bank Guarantees
A bank guarantee is essentially a promissory provision on a loan indicating that if the borrower of the loan defaults on repayment, the bank will cover the amount of default. This is a crucial provision to convince multiple companies to work together to complete a long-term project.
For example, if a construction company takes on the long-term project of building an office tower, that company needs to hire vendors and subcontractors to complete the project. In this example, the construction company that's overseeing the project could specialize in framing the office building, but it needs to subcontract with another company to install the thousands of window panes needed to complete the project.
The construction company might not be paid for its work until the end of the project. It needs to hire the window installation company on credit through a loan, since the thousands of window panes could cost more than a million dollars. This puts a lot of risk on the window installation company. The project could take longer than anticipated, or it could be scrapped due to a lack of funding from the group paying for the construction of the office building.
Having a bank guarantee in places reduces the risk to the window installation company because it knows that, no matter what happens, it will receive payment.