A bank guarantee (BG) is a written undertaking by a bank promising to pay a fixed sum to a beneficiary if the bank's customer (the applicant) fails to meet a contractual or financial obligation. It lets a buyer, government department, or trading partner rely on the applicant's promise with the bank's balance sheet standing behind it. If the applicant performs, the guarantee simply lapses on expiry; if it defaults, the beneficiary invokes the BG, the bank pays, and it then recovers the amount from the applicant.
Legal basis in India
A bank guarantee is a contract of guarantee governed by Sections 126 to 147 of the Indian Contract Act, 1872. Following a long line of Supreme Court rulings, Indian courts treat most commercial BGs as independent, on-demand instruments: the bank must honour a valid invocation strictly on the guarantee's own terms, without waiting for the underlying dispute between applicant and beneficiary to be resolved. Courts restrain payment only in narrow cases of established fraud or irretrievable injustice. RBI guidelines additionally govern how banks assess, price, and report the guarantees they issue.
Types of bank guarantee
BGs broadly split into financial guarantees (securing a money obligation) and performance guarantees (securing due performance of a contract). Common variants include:
- Performance guarantee — assures the beneficiary that the applicant will complete the contracted work.
- Financial guarantee — assures repayment of a loan, advance, or monetary commitment.
- Bid bond / tender guarantee — supports a bid so the applicant can participate in a tender.
- Advance payment guarantee — secures an advance paid to a contractor or supplier.
- Retention money guarantee — releases retention money the buyer would otherwise withhold.
- Customs / statutory guarantee — covers duty or obligations owed to a government authority.
How a bank guarantee works
The applicant applies to its bank, which appraises creditworthiness, security, and the exposure involved. On approval, the bank issues the BG in favour of the beneficiary for a defined amount and validity period, plus a claim window during which invocation is allowed. If the applicant defaults, the beneficiary submits a written invocation; the bank verifies it against the guarantee terms, pays, and debits the applicant's account or enforces the security held.
Charges, margin and GST
Costs vary with the bank, the type of BG, and the collateral offered. Commission is usually billed quarterly (or upfront) on the guarantee value, and the bank often blocks margin money as security.
| Component | Typical basis |
|---|---|
| Commission | A percentage of the guarantee amount, priced to risk, charged quarterly |
| Processing fee | A flat fee per BG |
| Margin money | Often 10% to 100% of the guarantee value, held as fixed deposit or lien |
| Stamp duty | As per the applicable state Stamp Act |
| GST | 18% on the commission and processing charges |
Going digital and what to watch for
Paper BGs are giving way to the Electronic Bank Guarantee (e-BG) issued on the Digital Document Execution platform of National e-Governance Services Ltd (NeSL). The RBI has pushed scheduled commercial banks to enable e-BGs, which use digital e-stamping and e-signing, cutting issuance from days to minutes and letting a beneficiary verify authenticity online instead of writing to the branch. When arranging a BG, read the invocation and expiry clauses closely, diarise the claim period, and formally seek cancellation and release of margin money once the obligation is discharged, as banks do not always close expired guarantees automatically.