What Is a Leased Bank Guarantee?
A leased bank guarantee is a bank guarantee that is leased to a third party for a specific fee. The issuing bank will conduct due diligence on the creditworthiness of the customer, looking to secure the bank guarantee. Following this it will lease a guarantee to that customer for a set amount of money and over a set period of time (typically less than two years).
The issuing bank will send the guarantee to the borrower's main bank, and the issuing bank then becomes a backer for debts incurred by the borrower, up to the guaranteed amount.
- A leased bank guarantee (BG) is the cash-backed bank guarantee of a third party for a fee.
- An issuing bank will lease a guarantee to a customer it has deemed to be creditworthy for a set fee and over a certain period of time.
- The issuer sends the guarantee to the customer's primary bank, taking the role of backer for any debts the customer accrues, up to the amount that has been guaranteed.
- Fees, which typically include an initial setup fee and an annual fee, tend to be expensive relative to the guarantee amount and compared to other types of financing.
- Smaller corporations tend to use leased bank guarantees, particularly when they are unable to secure another type of financing.
Understanding Leased Bank Guarantees
Leased bank guarantees tend to be very expensive; fees can run as high as 15% of the guarantee amount every year. The fee usually consists of an initial setup fee and an annual fee, both of which will be a percentage of the dollar amount that the issuing bank "guarantees" (or covers) in the event that the company is not able to promptly pay its debts.
Smaller enterprises typically only use this option for financial backing (particularly those who are desperate to expand operations and/or fund a specific project). These enterprises will have typically exhausted other opportunities to raise financing or obtain a letter of credit from their own bank.
Leased Bank Guarantee and Determining Credit-Worthiness
To determine if a borrower is worthy of a leased bank guarantee, many banks will undertake a credit analysis. Credit analyses focus on the ability of the organization to meet its debt obligations, focusing on default risk.
Lenders will generally work through the five Cs to determine credit risk: the applicant's credit history, capacity to repay, their capital, the loan's conditions, and associated collateral. This form of due diligence can revolve around liquidity and solvency ratios.
Many top worldwide banks will lease bank guarantees, usually with a minimum amount of $5 million to $10 million, all the way up to $10 billion and more.
Liquidity measures the ease with which an individual or company can meet its financial obligations with the current assets available to them, while solvency measures its ability to repay long-term debts. Specific liquidity ratios a credit analyst may use to determine short-term vitality are current ratio, quick ratio or acid test, and cash ratio. Solvency ratios might entail the interest coverage ratio.