What is the Difference Between a Bank Loan and a Bank Guarantee?
A bank loan is an offer of a loan facility by a bank to either their corporate or personal/private clients. A Bank Guarantee is a financial instrument issued by a bank. We will offer an explanation on both below.
The loan and the Bank Guarantee are offered by banks on a global basis. Whether here in Switzerland the USA or the Middle East, the terms and conditions will depend on the jurisdiction and country.
What is a Bank Loan?
A bank loan can take varying forms. There is the personal loan to private individuals. This is used for buying a car, a mortgage on a house, a holiday etc. All loans will have a fixed interest rate and a repayment date.
The Corporate Loan can take the form of short, medium or long-term loans. Short term loans may be just to cover salaries while waiting on payments for goods sold. Medium and long-term loans are for more in-depth financing. These loans often take the form of a Line of Credit.
It is important to ‘match fund’, making the term of the loan within the confines of the life of the asset that supports it. So, loans on cars will generally be within a 3 or 5 year term, whereas loans secured on real estate property could be up to 30 years, as property has a longer life than a car. Of course, machinery and other assets are similar and therefore the length and maximum term of any loan depends on the life and depreciation slope of the underlying asset.
Like a standard loan, a line of credit will have a repayment date. The client will be expected to repay part principal and interest repayments during the course of the loan. However, unlike a straight loan the client can reborrow at any time up to their credit limit.
A line of credit will cover all aspects of business. Day to day business expenses, fixed asset replacement or upgrading. Finance of imports or exports. This will allow the lender to understand where their finance is being spent.
Interestingly the client may need finance for a Letters of Credit or Bank Guarantees. This is where the Bank Loan and Bank Guarantee intertwine despite being two totally different forms of finance.
What is a Bank Guarantee?
A Bank Guarantee is a financial instrument. It is issued by a bank on instructions received from their client. It is a legal promise to pay the beneficiary by the issuing bank. Payment is made if the applicant fails in their fiscal and contractual obligations to the beneficiary.
A Bank Guarantee can take different forms such as a:
- Customs Guarantee
- Advance Payment Guarantee
- Tender Guarantee
- Contract Execution Guarantee
These are just a few of the guarantees that are available to corporate clients of a bank. A Bank Guarantee can also be utilised to access loans and lines of credit. This guarantee takes the form of a Demand Bank Guarantee. This guarantee is issued specifically for monetisation purposes.
Conclusion
As can be seen from above there is a world of difference between a Bank Loan and a Bank Guarantee. Interestingly a Bank Loan can be used to finance the issue of a Bank Guarantee.