Bank guarantees

A bank guarantee is a financial instrument to ensure performance of the obligations of the party undertaking agreeing to provide the guarantee.

It is a form of contractual security, with the bank (or any other financial institution or indeed third party acceptable to the beneficiary)agreeing to be responsible for the obligations of the principal party. In the event of default by the principal, the guarantor must honour the terms of the guarantee - usually involving the payment of an amount to cover the breach.

In reality, a bank would not extend a guarantee unless the principal had, in return, the assets to cover the bank's potential exposure. Thus, in this way it can be seen that the bank guarantee has the effect of securing the existing assets of the principal for the benefit of the beneficiary, but in a more liquid and accessible form - i.e. by relying upon the bank's existing cash resources (liquidity).

In the public procurement context, a successful tenderer may be required to provide a bank guarantee for a sum commensurate with the value of his obligations to perform under the public contract. In the event of default the contracting authority can invoke the guarantee against the bank.

Occasionally, guarantees may be required from inception of a tender submission.

The amount of the bank guarantee will be commensurate with the value of the obligations to be performed. As a matter of best practice, a fixed percentage ought not be publicized as to do so will immediately reveal the contracting authority's estimation of the value of the contract - and therefore the amount of money it can afford. This defeats the purpose of competition which is to encourage a range of prices, from which the lowest (or most economically advantageous) can be selected.