Bank Guarantee & Commission: Understand how bank guarantees work, how commission is calculated, and what businesses should know before applying.

Bank Guarantee & Commission – Meaning, Types & How It Works?

What Is a Bank Guarantee?

A Bank Guarantee is a financial commitment issued by a bank on behalf of its customer to protect a beneficiary against certain financial or contractual risks. If the customer fails to fulfill the obligations covered by the guarantee, the bank may be required to pay the beneficiary, subject to the guarantees terms and conditions. The bank charges a periodic commission fee (typically 0.20% to 0.75% per quarter in Bangladesh).

Bank guarantees are widely used in business transactions, construction projects, government tenders, international trade, and commercial agreements. They help build confidence between parties that may not have an established business relationship.

For example, a company participating in a construction tender may need to submit a bank guarantee to demonstrate its commitment to the project. If the company fails to meet the specified obligations, the beneficiary may be able to claim payment under the guarantee.

In simple terms, a bank guarantee provides financial assurance and helps businesses manage contractual risks.

Key Parties Involved in Bank Guarantee:

The bank guarantee process generally involves three parties: the applicant, the issuing bank, and the beneficiary.

• Applicant: The individual or business requesting the bank guarantee.
• Issuing bank: The financial institution that issues the guarantee after assessing the applicant and agreeing to the terms.
• Beneficiary: The person, company, or organization receiving the protection provided by the guarantee.

How a Bank Guarantee Works (step-by-step)?

 

The process usually begins when the applicant receives a contractual or tender requirement for a bank guarantee. The applicant then approaches a bank with the necessary documents and requests the required guarantee amount.

The bank evaluates the applicant's financial position, creditworthiness, business purpose, and available security. If the application is approved, the bank issues the guarantee in favor of the beneficiary.

1. Contract Agreement: Two parties sign a commercial contract, tender, or trade agreement that requires financial security.
2. Application: The applicant applies to their bank and submits required papers like the work order, tender notice, or contract terms.
3. Risk & Margin Assessment: The bank reviews the client’s creditworthiness and financial health. Depending on the risk, the bank may demand a cash margin (up to 100%) or physical property as collateral.
4. Issuance: Once approved, the bank issues the written guarantee to the beneficiary.
5. Fulfillment or Default:

·    If the applicant completes the job, the guarantee expires safely.

·    If the applicant defaults, the beneficiary invokes the guarantee, and the bank pays the promised amount immediately, then recovers the money from the applicant.

Common Types of Bank Guarantees:

Banks issue different types of guarantees depending on the transaction, contract, and beneficiary's requirements. The most common types include the following.

1. Bid Bond or Tender Guarantee:

A bid bond guarantee is commonly required when a business participates in a tender. It provides assurance to the tendering authority that the bidder will comply with specified bidding conditions.

Depending on the tender terms, the guarantee may be called if the successful bidder fails to fulfill particular obligations, such as signing the contract when required.

2. Performance Bank Guarantee:

A performance bank guarantee protects the beneficiary against certain losses arising from the applicant's failure to perform contractual obligations.

It is frequently used in construction, supply agreements, infrastructure projects, and service contracts. The guarantee amount, validity, and claim conditions are specified in the guarantee document.

3. Advance Payment Guarantee:

An advance payment guarantee provides protection when a buyer or project owner makes an advance payment to a supplier or contractor.

If the applicant fails to meet the relevant obligations, the beneficiary may be able to recover the covered amount under the guarantee's terms.

4. Financial Guarantee:

A financial guarantee supports specified financial obligations. It may provide assurance to a beneficiary that certain payment obligations will be met if the applicant defaults, subject to the wording of the guarantee.

5. Payment Guarantee:

A payment guarantee provides security for specified payment obligations under a commercial arrangement. It can help sellers, suppliers, and service providers manage the risk of non-payment.

The appropriate guarantee depends on the transaction and the beneficiary's requirements. Businesses should carefully review the required guarantee wording before requesting issuance.

What Is Bank Guarantee Commission?

Bank guarantee commission is the fee charged by a bank for issuing and maintaining a guarantee. The commission compensates the bank for providing the financial undertaking and assuming the risk associated with the guarantee.

The commission is usually influenced by several factors, including:

• The total amount of the bank guarantee.
• The commission rate applied by the bank.
• The guarantees validity period. Say for 5 years
• The applicant's creditworthiness and risk profile.
• The type of guarantee and the security provided.
• The bank's applicable fees, policies, and terms.

Different banks may apply different commission rates and calculation methods. Some may charge commission quarterly, half-yearly, annually, or for another specified period.

Therefore, applicants should review the bank's current schedule of charges before submitting an application.

It is important to remember that bank guarantee commission is not necessarily the only expense. Processing fees, applicable taxes, stamp duty, amendment charges, and other costs may also apply, depending on the bank and jurisdiction.

How Is Bank Guarantee Commission Calculated?

Bank guarantee commission is generally calculated using the guarantee amount, applicable commission rate, and chargeable period.

However, the precise calculation method depends on the issuing bank's terms.

For illustration, suppose a business requests a bank guarantee of BDT 10,00,000, and the hypothetical annual commission rate is 2%.

The estimated commission for one year would be:

Bank Guarantee Commission = Guarantee Amount × Annual Commission Rate

BDT 10,00,000 × 2% = BDT 20,000.

Under this simplified example, the annual commission would be BDT 20,000, excluding additional fees and taxes.

If the guarantee remains valid for less than a year, the bank may calculate the commission proportionately or apply a minimum charge, depending on its policy. Some banks may also calculate commission on a quarterly basis or require payment in advance.

This example is for educational purposes only and does not represent an actual bank's current commission rate. Applicants should confirm the applicable rate and calculation method directly with their chosen bank.

Letes Start with practical Examples- including Accounting Treatment:

For Better Understanding - [Learning Purpose only]

Practical Example-01:

In corporate Practice BD-Generally Bank guarantee are committed for 5 years. Bank Guarantee associated two parts for calculating margin and commission such as-

1.      Bank Guarantee Margin:

 An amount of % on Total amount of Bank Guaranteed agreement value in favor of customer by the bank. General in Bangladesh it occurs 20% of total granted amount.

The Formula we may use-

Bank Guarantee Margin = Bank Guarantee Amount@20% (if any) Bank Guarantee amount=Tk.1,50,00,000

                               Bank Guarantee Margin       = Tk.1,50,00,000@.20

                                                                 = Tk.30,00,000

2.      Bank guarantee Commission:

 An amount of % on total Guaranteed value per quarter. In Generally in Bangladesh, it occurs 0.20% per quarter of total granted amount also ,15% VAT applicable against Bank Guarantee Commission.

The Formula we may use-

Bank Guarantee Commission = Bank Guarantee Amount@0.20% per quarter (if any) Bank Guarantee amount=Tk.1,50,00,000

                                        =Tk.1,50,00,000@0.20%*20 = Tk.6,00,000

                                        

                                      Add: VAT 15%@Tk.6,00,000 = Tk.90,000

 

                                 Total Amount of Bank Guarantee = Tk.6,90,000

So, Total Amount to be paid from our CD Account as Bank guarantee margin & commission would be:

                                                   Bank Guarantee Margin (A) = Tk.30,00,000

                                           Bank Guarantee Commission (B) = Tk.6,90,000

Total Amount of Bank guarantee Commission for the 5 years (A+B) = Tk.36,90,00

Practical Example-02:

Bank Guarantee Margin & commission Charged by our CD Accounts whare as Bank Guarantee No.6000540.Guranted Amount of Tk.2,50,00,000 for 5 years where, Guarantee margin rate -20% and Bank Guarantee Commission rate-0.20 % per quarter with 15% VAT Applicable on Bank Guarantee Commission.

Required:

1.What is the Bank Guarantee Margin (B.G margin)?

2. What is the Bank Guarantee Commission for 5 years including VAT@15%?

Now we calculate necessary calculation as Requirement:

Bank Guarantee Margin (B.G margin):

Bank Guarantee Margin = (Bank Guarantee Amount* Bank Guarantee margin rate @20%)

                                       = Tk.2,50,00,000@20% =Tk.50,00,000

Bank Guarantee Commission for 5 years including VAT:

Bank Guarantee commission = (Bank Guarantee Amount* Bank Guarantee commission rate @.20%)

                                = (Tk.2,50,00,000@0.20%) =Tk.50,000@20 =Tk.10,00,000

Add: Applicable VAT rate@15% on Bank Guarantee Commission =(Tk.10,00,000@15%) =Tk.1,50,000

 Total Amount of Bank Guarantee Commission =Tk.11,50,000

Total Amount of Bank guarantee Margin & commission (50,00,000+11,50,000)   =Tk.61,50,000                                  

Note:1 quarter=3 month

5 years = (60/3) =20 quarter

When issuing Bank Guarantee no.002BG00540

Voucher No.01

                                                                          Bank payment Voucher:

Ledger Name	Debit (TK)	Credit (TK)	Remarks
B.G Margin No-002BG007540 SIBL	50,00,000
B.G Commission	11,50,000
ABC Bank Ltd CD-5860		61,50,000
Total Amount	61,50,000	61,50,000

Narration:

For issuing Bank Guarantee no.002BG007540TK. (2,50,00,000@20%) =Tk.50,00,000 & Bank

Guarantee Commission 0.20% per quarter +15% VAT (2,50,00,000@0.20%) *20+ VAT 15%) =Tk.(10,00,000+1,50,000) =Grand Total Amount = (50,00,000+11,50,000) =Tk.61,50,000 up to 24.09.2029, Bank payment dt.20.10.2024,

Practical Example-03: Bank Guarantee for a Government Tender

Suppose ABC Construction Ltd. wants to participate in a government construction tender in Bangladesh. The tender authority requires a bid guarantee of BDT 5,00,000. ABC Construction applies to its bank for the required guarantee.

Assume the bank charges a hypothetical annual commission rate of 2%.

Commission calculation:

• Bank guarantee amount: BDT 5,00,000
• Annual commission rate: 2%
• Guarantee period: 1 year

Bank Guarantee Commission = BDT 5,00,000 × 2% = BDT 10,000

In this example, ABC Construction would pay BDT 10,000 as commission for one year, excluding any applicable processing fees, taxes, or other charges.

Practical explanation: The bid guarantee assures the tender authority that the bidder will comply with the relevant tender conditions. If the bidder wins, further guarantees, such as a performance guarantee, may be required under the contract.

Practical Example-04: Performance Bank Guarantee for a Construction Project

Suppose XYZ Builders Ltd. signs a construction contract worth BDT 1 crore. The project owner requires a performance bank guarantee equal to 10% of the contract value.

The company approaches its bank to issue the guarantee.

Commission calculation:

• Total contract value: BDT 1,00,00,000
• Required guarantee percentage: 10%
• Bank guarantee amount: BDT 10,00,000
• Hypothetical annual commission rate: 2%
• Guarantee period: 1 year

Bank Guarantee Commission = BDT 10,00,000 × 2% = BDT 20,000

Therefore, the estimated annual commission would be BDT 20,000, excluding additional charges.

Practical explanation: If XYZ Builders fails to meet the covered contractual obligations, the project owner may make a claim under the guarantee in accordance with its terms. If the project is completed successfully, the guarantee can generally be released or allowed to expire according to its conditions.

Practical Example-05: Advance Payment Bank Guarantee for a Supplier

Suppose a manufacturing company orders industrial equipment worth BDT 20,00,000 from a supplier. The supplier requests an advance payment of 30% before beginning production.

The buyer agrees to pay the advance but requires an advance payment bank guarantee to protect the payment.

Advance payment calculation:

• Total equipment order: BDT 20,00,000
• Advance payment percentage: 30%
• Advance payment amount: BDT 6,00,000
• Hypothetical annual commission rate: 2%
• Guarantee period: 6 months

Assuming the bank calculates commission proportionately for six months:

Bank Guarantee Commission = BDT 6,00,000 × 2% × 6/12 = BDT 6,000

The estimated commission would be BDT 6,000, excluding other applicable charges and subject to the bank's actual calculation method.

Practical explanation: The guarantee provides protection for the covered advance payment if the supplier fails to fulfill the relevant obligations and the buyer makes a valid claim. The guarantee's reduction, expiry, and claim conditions should be reviewed carefully before signing the contract.

Practical Example-06: Bank Guarantee for a Commercial Payment Obligation:

Suppose a distributor enters into a commercial agreement with a supplier to purchase goods worth BDT 15,00,000. The supplier requests a bank guarantee to secure the distributor's payment obligations.

The distributor applies to its bank for a payment guarantee.

Commission calculation:

• Guaranteed amount: BDT 15,00,000
• Hypothetical annual commission rate: 1.5%
• Guarantee period: 1 year

Bank Guarantee Commission = BDT 15,00,000 × 1.5% = BDT 22,500

The estimated annual commission would be BDT 22,500, excluding applicable fees and taxes.

Practical explanation: The payment guarantee helps the supplier manage the risk of non-payment. If the distributor fails to meet the covered payment obligations, the supplier may submit a claim that satisfies the guarantee's requirements. The bank's liability is governed by the guarantee wording and applicable rules.

Important Note About These Examples

These four examples demonstrate how bank guarantee commission may be estimated for different business situations. The commission rates used are hypothetical and should not be treated as current rates offered by any bank in Bangladesh.

Actual bank guarantee charges depend on the issuing bank, guarantee type, amount, validity period, credit facility, collateral arrangements, and applicable fees and taxes. Always confirm the current commission rate and calculation method with your bank before applying.

What Documents Are Required for a Bank Guarantee?

The documents required for a bank guarantee vary by bank, business type, guarantee purpose, and risk assessment. However, applicants may commonly need to provide:

• A completed bank guarantee application form.
• Business registration documents and relevant identification.
• Trade license and tax identification documents, where applicable.
• Financial statements or other evidence of financial capacity.
• The tender notice, purchase order, contract, or other supporting documents.
• The beneficiary's name, address, and required guarantee details.
• Information about the guarantee amount and validity period.
• Collateral, cash margin, or credit facility documents, if required.

Banks may request additional documents depending on the applicant's existing banking relationship and the nature of the transaction.

Before applying, businesses should confirm the complete document checklist with the issuing bank. Providing accurate information and the correct guarantee wording can help reduce processing delays.

What Factors Affect Bank Guarantee Charges?

Bank guarantee charges are not always the same for every applicant. The total cost may depend on the amount guaranteed, the period of validity, the applicant's financial condition, and the level of risk accepted by the bank.

Collateral arrangements can also influence the bank's assessment. Some guarantees may require a cash margin or other security, while others may be issued under an approved credit facility.

Applicants should also check whether the bank charges separately for issuing, renewing, extending, amending, or cancelling a guarantee. Applicable taxes and government charges should be considered when estimating the total expense.

For corporate Practice in Bangladesh, comparing current bank schedules of charges and discussing the proposed transaction with the bank can help clarify the expected cost. The lowest commission rate should not be the only consideration; applicants should also assess service quality, processing time, terms, and suitability for the beneficiary's requirements.

How Can You Apply for a Bank Guarantee?

Applying for a bank guarantee generally involves a series of practical steps.

First, identify the purpose of the guarantee and confirm the exact requirements stated in the tender or contract. Determine the required amount, validity period, beneficiary details, and guarantee wording.

Second, select a bank and submit the application with the supporting documents. If you already have an approved credit facility with the bank, discuss whether it can be used for the proposed guarantee.

Third, the bank reviews your application, financial position, repayment capacity where relevant, and any required collateral or cash margin. It may request additional information before making its decision.

Fourth, review the proposed commission, other charges, and guarantee conditions. Ensure that the beneficiary's requirements are satisfied and that the wording accurately reflects the underlying contractual obligations.

Finally, after approval and completion of the bank's requirements, the guarantee is issued. Keep a copy of the guarantee, record its expiry date, and arrange any necessary extension well before the deadline.

Following these steps can help businesses prepare a complete application and manage their bank guarantee obligations more effectively.

Conclusion:

A bank guarantee is an important financial instrument that supports trust and security in commercial transactions. Understanding how a bank guarantee works, how commission is calculated, and which documents are required can help businesses prepare more effectively and avoid unexpected costs.

Before applying, compare bank guarantee commission rates, review all applicable charges, and confirm the guarantees terms with your bank. Careful planning can help you choose a suitable guarantee for your tender, contract, or business transaction while managing financial risks responsibly.

Frequently Asked Question (FAQs):

Place these questions near the end of your article under the heading Frequently Asked Questions About Bank Guarantee. The answers are concise, direct, and suitable for readers seeking quick explanations.

1. What is a bank guarantee and how does it work?

A bank guarantee is a written undertaking by a bank to pay a beneficiary up to a specified amount if the applicant fails to meet the obligations covered by the guarantee and the claim satisfies its terms. It helps reduce financial risk in business transactions, contracts, and tenders.

2. How is bank guarantee commission calculated?

Bank guarantee commission is generally calculated using the guaranteed amount, the commission rate, and the guarantee period. Banks may also charge processing fees, taxes, stamp duty, and other applicable costs. The exact rate and calculation method depend on the bank's schedule of charges and the guarantee terms.

3. What are the main types of bank guarantees?

The main types of bank guarantees include bid bond guarantees, performance guarantees, advance payment guarantees, financial guarantees, and payment guarantees. Each type serves a different purpose, depending on the contractual obligations and the risks involved.

4. What documents are required to obtain a bank guarantee?

Common requirements include a completed application, business identification documents, financial statements, the underlying contract or tender documents, and details of the beneficiary. Depending on the bank and the applicant's credit profile, additional collateral, cash margin, or a credit facility may be required.