A traditional bank loan includes a credit application and a conditional transfer of money from the bank to the borrower. Bank guarantees, on the other hand, have no direct money transfer.
Instead, banks issue guarantees as a guarantee for a third party on behalf of one of the bank’s customers. If the bank’s client does not fulfill a specific contractual obligation with the third party, that party can call the bank guarantee and receive the payment.
Traditional bank loan
One of the most important functions of banks is to accept money from people with an excess of available funds (savers) and to rent money to people with insufficient funds (borrowers). A traditional bank loan includes a lump-sum transfer of money to a borrower. The borrower promises to repay the loan with interest over a certain period.
Before a bank provides a loan, it examines the probability that the borrower will repay the money as stated in the note. Borrowers who are considered too risky can borrow smaller amounts, charge higher interest rates, pledge collateral or refuse the loan altogether. There are many different types of bank loans that are designed for different customers and purchases.
Bank guarantees act as a form of insurance for a third party that has a contractual relationship with one of the bank’s customers. This is best demonstrated with an example.
Suppose a private contractor negotiates a job with a municipal government to build a project. The government has never had to deal with this specific contractor before and is suspicious of the risk of working with a new entity.
The government can only accept the contractor’s offer on condition that the contractor receives a guarantee from his bank. The guarantee states that in the event of default by the contractor, the bank agrees to pay an amount to the government. In this case, the government is the beneficiary of the guarantee.