A bank guarantee can be defined as something that is leased to a third party for a specific fee. In this case, customer’s creditworthiness is conducted by the issuing bank. Thereafter, a guarantee is leased to that specific customer for a set amount of money and over a fixed time period (usually less 24 months). This guarantee is sent by issuing bank will send the guarantee to the main bank of the borrower. Here, issuing bank will serve as a backer for debts incurred by the borrower, up to the guaranteed amount.
Usually leased bank guarantees are quite expensive. The fees can run as high as 15 percent of the guarantee amount on a yearly basis. The fee for the same comprises of the following:
- Initial setup fee
- Annual fee
Both of the above will be a percentage of the dollar amount to be “guaranteed”. This may also be a percentage covered by the issuing bank in case; the company remains unable to pay its debts at the appointed time.
This option of financial backing offered by leased bank guarantee providers is typically only used by smaller enterprises that are desperate to expand operations or fund a specific project; they will have typically exhausted other opportunities to raise finance or obtain a letter of credit from their own bank.
Most of the top banks across the world will lease bank guarantees. This is usually done with a minimum amount of $5 million to $10 million. This may go up to $10 billion and more.
Since it is essentially not possible to lease a bank guarantee in this way, leasing may not be the apt term to use. It is a misleading term. The term is loosely used because the process is nearly exactly that of commercial leasing. Basically, the Provider offers temporary ownership of his assets to the Beneficiary in exchange for a fee. Towards the end of the term, ownership of provider will get the assets back. These assets are utilized towards raising specific and non-transferable bank indemnities that may be used by the Beneficiary.
This is a misnomer because no leasing actually takes place. Using a Collateral Transfer Agreement, a Provider will approve for placing his assets with a facilitating bank. Under these circumstances, the bank will charge the asset and raise a bank indemnity against it in favour of the Beneficiary. Usually, this bank indemnity comes in the form of a Bank Guarantee issued specially for the purpose towards the Beneficiary.
Understanding Collateral Transfer
Also referred to as Collateral Provision, Collateral Transfer is the provision of assets from a specific party (the Provider) to another party (the Beneficiary). This is done under a Collateral Transfer Agreement. In this case, the Provider will effectually ‘lease’ his assets to the Beneficiary for a specific term or for a collateral fee.
Usually, the term of ‘lease’ would be 12 months. However, this can be extended to anywhere between 3 and 5 years, depending on the wish of the Provider. Towards the end of the term, the Beneficiary will return the collateral or allow it to lapse and indemnify the Provider against any losses that may be caused by the Beneficiary using collateral or raising credit against it while it has been in his/her possession.
The transaction conditions will be ruled by the Collateral Transfer Agreement as far as the Beneficiary agrees to dowse any lien or credit raised against the Bank Guarantee before its expiry. Here, the Beneficiary will make provision that any loans secured against it are repaid towards the end of the Agreement term.
As a result, the Bank Guarantee being received by the Beneficiary is actually a Bank Guarantee issued for its anticipated purpose such as for security and credit lines. However, it should not be considered as a ‘leased bank guarantee’. Here, Provider’s underlying assets are effectively being leased. In short, monetizing or credit lining these types of bank guarantees are quite similar to credit lining other bank guarantees issued for raising credit.
Hence, Collateral Transfer makes for an effective way for providers earn increased revenue from their assets. Beneficiaries will also benefit with this for raising bank credit.
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