Differance between financial bank guarantee & performance bg

This query is : Resolved 

09 August 2011

Dear Sir,

Request you to clearly define financial bank guarantee and performance bank guarantee and pls bringout the differance between those two and pls sepcify the below whether financial bank guarantee or performance guarantee.
1.Bid bond/ EMD
2. Mobilisation advance
3. Retension money
4. Security deposit
Request you to revert at the earliest as the need to clarify to my collegues.

CMA Ramesh Krishnan (Expert)
10 August 2011

The financial guarantees and performance guarantees issued by banks on behalf of their clients. A financial guarantee assures repayment of money. (e.g. an advance received on an electrification contract), in the event of non-completion of the contract by the client.

A performance guarantee provides an assurance of compensation in the event of inadequate or delayed performance on a contract. A deferred payment guarantee promises payment of installments due to a supplier of machinery or equipment.

EMD which security deposit for tender purpose

Mobilisation advance is the advance given to any contractor by the contractee for start the contract work

Retention money means the money with held by the contractee based on contract term for some period

Sachidanand Singh (Expert)
10 August 2011

In both financial guarantee and performance guarantee a bank assures its customer’s client that in case the client makes a demand on the bank (i.e. invokes the guarantee) the bank will immediately pay a certain amount. In both cases the guarantees are valid till a certain pre specified date. No claim under the guarantees can be made after that date.

It must be clearly understood that in a performance guarantee the bank does not guarantee to perform. It merely guarantees that if its customer fails to perform it will be liable to pay the guarantee money and its customer’s client is the sole arbiter of its customer's performance.

Where a bank guarantee is to be used for proposal security or earnest money deposit (the two are one and the same thing) it is a financial guarantee. The guarantee merely replaces the security amount. The bank while issuing such a guarantee does not have to assess its customer’s ability to perform; it merely assesses its customer’s ability to pay.

Where a guarantee is required to be given to the tender authorities (the bank’s customer’s clients) for release of mobilization advance (which as CMA Ramesh Krishnan has rightly described as the advance given to a contractor to enable him to start work on the contract) the guarantee is a performance guarantee. The bank while issuing such a guarantee needs to assess whether its customer will be able to start the work within the stipulated time or not. This assessment theoretically is different from a mere credit analysis which is banks’ staple diet.

Similarly a guarantee to be submitted for release of retention money (part of payment usually, around 10%, that tender authorities tend to retain i.e. not release as a security against non-performance of the work delivered by a contractor) is a performance guarantee.
Earlier (go back by 50 years or so) banks were wary of issuing performance guarantees as they felt they were not in a position to assess their customers’ ability to perform. (Please remember all projects are different.) For issuing performance guarantees they charged higher commission than what they did for issuing financial guarantees. Though the assessment is now considered not very difficult and in most cases banks hardly spend more (or more costly) executive time in assessing ability to perform than they do in credit assessment, still they are loath to let go of an opportunity to earn more and the system of charging higher commission for performance guarantees continues.

A bid bond is a bank guarantee which is submitted in lieu of earnest money deposit (or proposal security).

EMDs and Retention Monies are security deposits – as they give the client a sense of security that the contractor is serious (while submitting the bid i.e. the tender) and will deliver works of required quality. Often tender authorities demand performance security or security deposits for allowing the contractor to start work such deposits give them a sense of security that the contractor will not walk off mid-way.

Except EMD, gurantees for all other purposes mentioned here are performance guarantees.

Other examples of financial guarantees are guarantees to be given to statutory bodies in lieu of deposits for example to electricity boards fro getting (HT) connections, to Customs and Excise people pending appeals etc.

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